Older clients often want to talk about helping with the cost of grandchildren’s education, and the question may be raised – what about setting up a Trust?
An “Accumulation and Maintenance” (A&M) Trust was a conventional answer up to about 5 years ago, for those who had the funds, but changes to the taxation of trusts over the past few years have reduced their attractions. However, there are alternatives such as a “Bare Trust”.
One problem with setting up a formal A&M Trust is that it will cost a few hundred pounds. It may then cost a few more hundred pounds to administer year by year, maintaining trust accounts and submitting trust tax returns. The complexity will depend on the investments held within the trust, but it would probably not be cost-effective to set up and run an A&M Trust with less than £100,000.
Up to 2007, an A&M Trust could be set up without triggering an immediate Inheritance Tax (IHT) liability, but now any lifetime gift over the nil rate band of £325,000 will be subject to IHT on the excess at 20%. That may not be a disaster in that if two grandparents both allocate funds, a total of £650,000 might be put into trust to cover their grandchildren’s education without paying IHT up front. All they have to do is survive for seven years and the lifetime gift falls out of account, with the risk of early death being coverable by insurance, given normal health for age.
With private day school fees at about £5,000 per term (£15,000 pa) and full boarding at £10,000 per term (£30,000 pa) the cost of putting one child through private education over ten years (without allowing for inflation) might be £225,000. An initial allocation of £650,000 between two grandparents, if invested well, might cover the bulk of education expenses for three grandchildren.
The advantage of a trust set up by grandparents over one established by parents, is that the trust income can be taxed as the children’s own, taking advantage of their individual personal income tax allowances. In the case of a trust established by parents, the income will continue to be taxed as if it was the parents’, until such time as the children reach 18. The CGT allowance for an A&M Trust (£5,300 in 2012/13) is half the full personal allowance (£10,600 in 2012/13).
As to alternatives, for families who do not have large sums of capital to give away, a “Bare Trust” may be a simpler solution. An “absolute gift” to individual grandchildren will need trustees (typically their parents) to look after the funds for them whilst they are under 18.
The advantage of the absolute gift or “Bare Trust” from a grandparent is that any investment income is treated as the child’s in the first place, taking advantage of its personal income tax allowance (£8,105 for 2012/13) and also the child’s own capital gains tax allowance (£10,600 for 1012/13).
The child’s fund will typically be invested in the joint names of its parents, suitably designated to avoid confusion with their own funds, within the terms of a simple trust deed which confers administrative powers.
One disadvantage of a Bare Trust is that it cannot be diverted to benefit other children in the same family. If the child dies under 18 the trust fund will pass under the intestacy laws, usually to its parents.
A Bare Trust needs to be properly documented to avoid being treated as a proper “Settlement” by HMRC, while the key to financial success will lie in the hands of a suitably experienced financial adviser, selecting specific investments which may grow faster than the rate at which school fees themselves inflate!