Back to School!
According to the Independent Schools Council Annual Census in 2017, the average fees per term range from £3,400 in the North West to £5,500 in London. Meanwhile university tuition fees in England can now be as high as £9,250 per year, with living costs on top. This causes a headache for most fee-paying parents. However, if the grandparents can help this can be rather tax efficient.
Grandparents may wish to invest a lump sum in a tax efficient investment such as a bond. However, if the grandparents hold the bond personally, then on encashment of segments to meet the school fees, any tax liability will be based on Grandparents. One way to avoid or reduce this tax would be to place the bond under a bare trust.
Trustees will hold the bond. A bare or absolute trust is for a named beneficiary or beneficiaries and it states at outset the share of the assets for each beneficiary. This share cannot be altered in the future. A discretionary trust could be used where all beneficiaries are merely ‘potential’ beneficiaries and the trustees decide who gets what and when. However, under a discretionary trust, the tax treatment of any gains on the bond would fall back on the grandparents marginal rate while they are alive and then at the rate applicable to trusts (currently 45% after the £1,000 standard rate band has been utilised) from the tax year after the grandparents died.
The downside to bare trusts is that the child could demand the whole of their share when they reach age 18 – but it is likely that the school fees will have used up virtually the entire trust fund.
There are two different ways of extracting cash when the fees are due. The trustees can take a partial withdrawal across all segments. They have a cumulative annual allowance of 5 per cent of the original investment which is tax-deferred. This means that the tax will not fall due until the final encashment of the segment or bond. However, tax would potentially be due on any excess withdrawal over the cumulative 5% withdrawals.
Alternatively, the trustees can fully encash one or more segments. This could result in an immediate tax charge but, when using a bare trust for grandchildren, any tax liability will fall on the beneficiary and, the grandchildren would probably be non-taxpayers.
When considering these trusts, it must be remembered that you are making a potentially exempt transfer if going down the bare trust route or a chargeable lifetime transfer choosing a discretionary trust route. These both take seven years to fall outside of your estate for Inheritance Tax purposes and, therefore, if you are considering doing any other estate planning, care must be taken to ensure you follow the preferred order of gifting.
For advice on Trusts and Inheritance Tax, contact Ann Bibby.