Many parents value a private school or university education for their children but the cost continues to increase and can be hugely expensive over time. Parents can expect to pay £275,0001 for a private day school education between 4 and 18 years old and significantly more if children are boarding. Children not at private school but choosing to go to university can also build up significant debt from a combination of tuition fees and living costs over the duration of their studies.
Many grandparents will be keen to help with the cost of education for their grandchildren and may already be paying school or university fees directly out of their own income or investments. However, there may be an alternative option to consider; the bare trust.
The word ‘trust’ can ring alarm bells. Trusts can be complex, costly and involve considerable ongoing administration. A bare trust is more like a nominee arrangement than a conventional trust. A grandparent can open an investment account designated for their grandchild, with a gift, and the account acts as a default bare trust. The account can pay education fees directly.
The big advantage of a bare trust is the tax treatment. The money inside a bare trust is treated for tax purposes as if it belongs to the child. Grandchildren can use their own personal income tax allowance, personal savings allowance, capital gains tax exemption and dividend allowance each year.
In the new 2018/19 tax year this could allow income of £19,850 to be generated in the trust before any income tax is payable, assuming the grandchild has no other income. This is very tax efficient.
Other advantages of a bare trust:
- There are no immediate tax implications for a grandparent making a cash gift into a bare trust. When you make a gift to a bare trust it is considered a ‘potentially exempt transfer’ or PET. This means that you must survive seven years from the date of making the gift before the amount of the gift is outside of your estate for IHT purposes. If you die within the seven year period there may be IHT to pay.
- Whilst the child is under the age of 18 grandparents can control, in conjunction with parents, the money in each trust.
- If the grandchild has no other income, and income and capital gains generated within the trust are within their personal allowances, they should not need to complete a tax return.
- If the grandparents die before the grandchild is 18, the money in the trust is unaffected and education fees can continue to be paid.
- In comparison to a discretionary trust, a bare trust is more straightforward, cost effective and involves less administration.
- Grandparents can set up an account designated for each grandchild at Brown Shipley. These accounts will act as bare trusts. The money in the accounts can be invested in line with your attitude to investment risk. You can set and control investment strategy and manage the payment of education fees.
Of course, there are always disadvantages to consider and taking advice is important. A common objection to a bare trust is that the grandchild becomes absolutely entitled to any money or investments remaining in the trust at age 18.
Some grandparents may baulk at the thought of giving a young person access to large sums of money. However, if the costs are known or can be estimated at outset the trust can be funded sufficiently to pay fees and leave a minimal balance by the time the grandchild reaches 18. If there is a balance remaining at 18 the grandchild could choose to use the funds for other purposes such as university fees or for a deposit on a first home. However, it would be their decision.
Before making significant gifts of capital, grandparents should always ensure their own long-term financial security. A cash flow plan will help here by looking at income and assets and the affordability of gifts.
The focus of this article has been on grandparents but can this type of planning also work for parents? Unfortunately, the answer is no. Using a bare trust where parents are gifting money offers no tax advantages and this is because of anti-avoidance rules.
If a parent establishes a bare trust, any income that arises is treated for income tax purposes as theirs and taxed at their marginal rate(s). These rules apply to trusts where a child under 18 is a beneficiary but the parent making the gift receives no benefit.
Other points to bear in mind:
- A gift made by grandparents to a bare trust is irrevocable and cannot be repaid.
- There is no flexibility in terms of future beneficiaries as the trust has been set up absolutely for the benefit of the grandchild. In the event that the grandchild dies any money or assets in the trust form part of their estate for inheritance tax purposes.
- If income and gains generated in the bare trust exceed the grandchild’s personal tax allowances they may need to complete an annual tax return.
- Any money or assets remaining in the trust when the grandchild reaches 18 will become theirs outright. They will have full control over what to do with the assets at this point.
- If the grandparent dies within seven years of making the gift to the bare trust there may be inheritance tax to pay. The amount of inheritance tax payable reduces on a sliding scale once three years have passed since the date the gift was made. Once seven complete years have passed the value of the gift is no longer counted as part of the grandparent’s estate.
1 Assuming costs of £15,000 per child each year inflating by 4% from age 4 to 18.
Rebecca Williams, Client Director