Discretionary trusts are the most popular choice for grandparents who want to leave money to their grandchildren. By creating a trust, one can name recipients of the trust’s assets, but the trustees are free to use those funds anyway they see appropriate. These trusts can be established during someone’s lifetime or through a last Will and testament, and can last for up to 125 years. The fundamental principle underlying the functioning of these trusts is that the beneficiaries do not have an absolute right to the trust’s assets. In this article, Trust For Grandchild, we take a look at these issues in more depth.
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Why grandparents may look to help their grandchildren
There are a variety of personal and financial factors that can influence a grandparent’s decision to provide for their grandchildren independently of their children.
One major reason someone would leave their fortune to their grandchildren instead of their children is if the children have already established themselves financially. They will be in a more precarious position with respect to Inheritance Tax if their parents leave them any more assets or funds as an inheritance, either during their lifetimes or upon their deaths. Hence, helping your children with their own estate planning by skipping a generation and leaving an inheritance to the grandchildren can be a useful thing to do.
A parent may be hesitant to leave assets to their children if they have any reason to be concerned about the welfare of those children, such as a history of financial mismanagement or an unsavoury romantic relationship. And some people just want to assist their grandchildren out financially, whether it’s for college or a house deposit.
Different types of Trusts
Below, we go into a bit more detail on two specific types of trusts that are an established and effective way to provide for grandchildren while retaining some measure of control over the assets:
Bare trust
If your grandchildren are under the age of 18, a bare trust may be a helpful option.
When you name a trustee (or name yourself as trustee), they are responsible for keeping your assets safe and managing them on your behalf. The funds in the bare trust can be spent on things like tuition and travel, as long as those things are for the sole benefit of the beneficiary.
However, once the beneficiary reaches 18, they have the legal right to request that the trust assets be transferred to them. The bare trust can continue until that time. If you want to set up a bare trust for the benefit of more than one grandchild, you should set up individual trusts for each grandchild.
In the same manner that a gift to an individual is taxed, so too is a donation to a bare trust. Depending on the specifics of the donation, it may be an exempt transfer or a PET (Potentially Exempt Transfer)
The trust’s beneficiary must pay taxes on any income or gains generated by the trust’s bare assets. If the income generated by the trust is less than the child’s personal allowance, then no income tax will be due. This is especially true if your minor grandchildren have little or no other taxable income.
Discretionary trust
Distributing trust income or principal to beneficiaries is totally up to the trustees’ discretion in a discretionary trust.
A discretionary trust differs from a bare trust in that a beneficiary does not have the right to request distribution of trust assets upon reaching the age of majority. If you do not feel comfortable with the concept of the beneficiaries having access to a substantial lump sum at a young age, or if you want the beneficiaries to continue receiving benefits from the trust into adulthood (maybe to help with a first home or wedding), a discretionary trust is a preferable alternative.
Apart from a bare trust, a discretionary trust has a unique tax status.
- For the purposes of IHT, the transfer of assets into the trust is considered a “chargeable lifetime transfer” (CLT). If the value of the transferred assets exceeds the £325,000 nil-rate band, an immediate IHT charge of up to 20% may be imposed. IHT reliefs can lower or remove this fee for some assets. You can avoid paying IHT on transfers into trust of up to £325,000 if you make gifts to the trustees every seven years and then outlive them by the same amount of time.
- An IHT charge of up to 6% of the value of the trust assets per decade will be levied against the trustees once the assets have been transferred to the trust. Also, when a recipient receives a distribution of capital, they may be liable to an IHT “exit fee,” which can add another 6% to the bill.
- The trustees are subject to income and capital gains tax on any money they earn or gain from managing the trust.
- Income distributions are taxed to the recipient at their individual marginal tax rate. The trustees will have paid taxes that will be credited towards the payout. As long as the trustees have already paid enough income tax to match the distribution, the recipient will not owe any further income tax and may even be eligible to receive a tax refund from HMRC.
- Capital distributions are not taxed to the recipient.
Should any gift be an outright gift or a gift into trust?
If you want to leave money to your grandchildren in your Will or during your lifetime, you need to determine whether you want to leave the money outright or put it into a trust.
Minors under the age of eighteen are not allowed to be legal owners of property. Therefore, any outright gifts made to them before they turn 18 will be theirs beneficially, but the legal title to (and control of) such assets will be held in the names of one or more chosen adults (usually their parents) as “bare trustees,” and will pass into their own names and directly under their control once they turn 18.
The decision of whether to make an outright gift or a donation into trust is very personal and can be influenced by a variety of factors, including the donor’s age, marital status, and financial situation. There are many factors to think about and get advice on, such as the age and personal circumstances of the recipient, the nature or value of the gift, whether they are happy for the recipient to do with the gift as they please or whether they wish to restrict that, the set-up and ongoing costs of running a trust, and the associated tax charges (and benefits).
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How to Contact Our Private Client Solicitors
It is important for you to be well informed about the issues and possible implications of setting up a trust for a grandchild. However, expert legal support is crucial in terms of ensuring a positive outcome to your case.
To speak to our Trust solicitors today, simply call us on 0345 901 0445, or click here to make a free enquiry. We are well known across the country and can assist wherever you are based. We also have offices based in Cheshire and London.
Disclaimer: This article provides general information only and does not constitute legal advice on any individual circumstances.
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