With all the children now back at school in the new academic year, and for those who have chosen a private education for their children, the significant costs involved can be a great expense for many people. In addition to this, for many school leavers going onto University, tuition fees and living costs should also be factored in, although there is potentially the option of student loans to cover tuition fees and some maintenance costs. It is worth considering whether there are any tax-effective strategies that could be used to potentially ease the financial burden.
When grandparents are in the fortunate position of being able to help with the funding of education costs, their gifts can be a tax-efficient way of paying school and university fees. This applies in particular, for those who are looking to reduce the level of their estates with a view to mitigating their potential exposure to inheritance tax (IHT).
Some key points in IHT planning, which could help to benefit the younger generations are considered below:
IHT free gifts
Each grandparent has an annual £3,000 IHT free gift allowance which can be carried forward for one year if unused. Therefore a couple could make an annual gift of £6,000 with no IHT consequences.
There is also another IHT exemption available to people who have income at a level which is ‘surplus’ to their requirements. This exemption is subject to certain conditions and any payments need to be regular and documented but this could be used to prevent the level of the grandparent’s estate increasing any further whilst assisting in the education and development of their grandchildren.
Larger amounts can also be gifted and will be free of IHT if the donor survives for seven years after making the gift, although, the rate of IHT reduces once a three year survivorship period is reached as gifts made between three and seven years before the death are taxed on a sliding scale due. As an example, any gifts made between six and seven years before death will be subject to IHT at a much reduced rate of 8%.
Use of Discretionary trusts
An individual can give up to £325,000, being the amount of the IHT nil rate band, to a discretionary trust without triggering an IHT liability (assuming that no previous gifts have been made). It does take seven years for this gift to fall out of the individual’s estate but once the seven year period has been reached the £325,000 nil rate band is effectively ‘regenerated’.
Therefore, for a couple with the available funds, a discretionary trust could be set up with capital of £650,000 using two available nil rate bands, with the grandchildren as the beneficiaries. Discretionary payments could be made to assist with school fees when required.
Whilst this strategy reduces the estate of the transferor potentially saving IHT at 40%, there are additional income tax advantages for the trust’s beneficiaries as the trustees could make use of the income tax personal allowances of the grandchildren.
As an overview, the trust will pay income tax at 45%, if this income is then distributed to a beneficiary, the receipt is shown to have tax paid of 45%. If the income is distributed to a beneficiary who is a non-taxpayer, then a significant amount of tax could be reclaimed by the beneficiary using their personal allowances.
In comparison to making an outright gift, the use of a trust can enable a grandparent to retain some control of the trust funds, and along with the other trustees be able to direct who the distributions are made to and for what purpose.
In summary, the overall effects of making use of IHT annual exemptions, gifting out of ‘surplus’ income, or setting up a discretionary trust to pay school and university fees can be hugely beneficial to the whole family and could definitely be worth pursuing further.
IHT is a complex area so please speak to one of our tax experts if you would like to discuss this any further. Our initial consultation will be free of charge.
Information for readers: This material is published for the information of clients. It provides only an overview of the regulations in force at the date of publication, and no action should be taken without consulting the detailed legislation or seeking professional advice. Therefore no responsibility for loss occasioned by any person acting or refraining from action as a result of the material can be accepted by the authors or the firm.