Do you Trust the children? How to help the younger generation without paying too much tax
16/01/2010
By Jeremy Passmore, Partner and Head of Private Client. Featured in Kent on Saturday.
Many people want to provide funds for their children and grandchildren, to help with all the varied calls for money that they will experience during their younger years and into adulthood. It is not always easy to know how best to structure any such provision. One wants to ensure that children have an appropriate degree of access to the monies, and that the structure serves to minimise the impact of taxes.
- Bare Trusts - are arrangements where trustees are acting really only as nominees, with the beneficiaries having beneficial ownership of the monies. Where funds are provided by grandparents, grandchildren can use their personal allowances for Income Tax and annual exemptions for CGT, which is likely to be better than if the monies were held by the parents or grandparents. If the funds are provided by parents, however, income tax is assessed on them until the children reach eighteen.
A disadvantage is that at eighteen the children can call for the money which belongs to them; because it might be spent unwisely does perhaps mean that such trusts should not be over funded, to leave an eighteen year old with too much to spend. Whilst they are under eighteen, the monies can be used freely for their benefit, including paying school fees.
- Discretionary Trusts - are used when the amount is more than would be appropriate for the children to take at eighteen; or where it is intended that the funds should be held to give benefit to the beneficiaries until a greater age such as twenty five; or where one wants to have the ability to favour some beneficiaries over others. Such trusts are very flexible and can target the benefit at the appropriate time.
A disadvantage with such a trust is that the trustees will need to manage the funds and produce a separate tax return; with a bare trust the income is simply treated as belonging to the child and only a tax repayment claim will be needed. Furthermore, Income tax rates for trustees are now high, with a 50% rate from April. The effect of this is mitigated if the income is paid out to beneficiaries who are non or lower rate tax payers. Accordingly it would normally be best to fund the trust at the sort of level where income being generated can safely be paid out, to avoid the trustees retaining income and suffering tax at 50%.
Once again there is a difference if the funds are provided by a parent, with the tax assessed on the parent if the income is distributed; but if the income is accumulated, then it will be taxed at 50%! So if parents want to get funds out of their estates, perhaps for IHT reasons, it would be wise not to invest to produce a high level of income whilst the children are under age, although once they reach eighteen the rules change and income paid out to the children is taxed on them and not their parent.
- Provision by Will - Grandparents can bypass their own children and set up trusts for grandchildren in their Wills. The parents will probably benefit indirectly from the funds available and the trust can be drafted so that the children's own personal tax position can be taken advantage of. Some trusts for children are hit by an IHT charge. This will not happen if the fund is below the nil rate band threshold, currently £325,000. If someone wants to set up a larger fund, then there are ways to avoid any IHT charge by giving the children a right to income.
The circumstances and requirements of families differ greatly; one needs to think carefully about what one is trying to achieve and to structure gifts to achieve that in the most appropriate and tax effective way.