There comes a time in some people’s lives when their thoughts turn to their grandchildren and whether they can help ensure that they get a good education and a proper start in life. Family trusts offer a way to do this while also offering tax savings.
Recent media coverage over university fees has made it clear that, whatever happens in the future, educating children is not going to get any cheaper.
It is perhaps a little surprising that despite the 2006 changes to the tax regime for trusts, there are significant tax savings available. One of the more common areas these can be found is where grandparents set up trusts to help their grandchildren through education and beyond.
What is a trust?
Setting up a trust needn’t be intimidating. It is simply a way of passing the benefit of assets to other people without them taking possession of the funds outright. You can retain control of the capital, continuing to manage the investments as you wish, while ensuring it is used to benefit future generations.
In addition to the tax benefits, a trust can help protect the assets that form the trust fund against difficult situations in the future, such as the divorce or bankruptcy of one of the beneficiaries.
What are the benefits?
Perhaps one of the most powerful benefits of a trust is its flexibility: it can be as constrained or as wide-reaching as you like.
For example, you could instruct that income has to be split between children equally regardless of their circumstances, or you could leave it to the trustees to decide annually who should receive what in light of their changing circumstances.
Trusts should always be drafted by a professional to avoid legal pitfalls.
What is the tax position?
Where the person who creates the trust is excluded from benefit – that is, they cannot get the money back themselves – the tax consequences are not particularly harsh. Each person can give away up to £325,000 of assets without incurring an inheritance tax (IHT) charge, so long as they have not made significant gifts in the previous seven years. A couple could therefore place £650,000 into trust without incurring an IHT charge.
If there would normally be a capital gains tax (CGT) charge on transferring these assets, the donor can claim to ‘hold-over’ the gain into the hands of the trustees, so that there is no tax charge until the assets are sold later. Even transfers of property will normally be exempt from stamp duty land tax unless there is a mortgage involved.
The trust itself pays tax as if it were an additional rate taxpayer, so income tax is applied at 50% and CGT at 28%. However, if the income is then handed out to the children, they can recover much of the tax that the trustees will have paid. It is also possible to set the trust up so that the income goes to the children automatically, in which case the trust does not pay any income tax at all.
This means that rather than the grandparents paying tax at 40% or even 50%, income generated by the assets in trust can be used to meet the costs of a child’s education and maintenance, with tax at 0% on the first £6,475 (£7,475 from 1 April 2011) per child, and then 20%. If the child has income of their own, this will affect the tax rate; unusually high levels of income will also affect this situation.
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Image: (CC) Lordcolus