A recent article in the Investors Chronicle, talks about how grandparents can help to fund school fees.
This week, hundreds of thousands of 18-year-olds in England and Wales will receive their A-level results. But sending children to private school, or on to university, is becoming a huge financial commitment. Figures from the Independent Schools Council show that where three children between the ages of eight and 18 are at an independent school simultaneously, the average cost can reach more than £60,000 in one year alone.
Grandparents are increasingly stepping in to help alleviate some of this burden. Aside from the good deed of funding their grandchildren's education, drip-feeding those school fees can have other advantages.
Paul Barry, a chartered financial planner at Duncan Lawrie Private Bank, says discretionary trusts are a useful way for people to earmark assets for certain beneficiaries or purposes. But the real bonus is the efficient use of inheritance tax (IHT) allowances that comes as a result.
The nil-rate band - the amount individuals can offset as part of the IHT threshold - is currently £325,000. The setting up of a discretionary trust will not incur an immediate tax bill and, provided the donor survives for seven years after making the contribution, the gift falls outside their estate under IHT rules.
Dominic O'Connell, executive director, head of tax trust and estate planning at Coutts, explains: "While the donor's seven-year 'clock' for IHT purposes commences, it does not require the funds to be passed immediately to the beneficiary - payment will only be made at the trustees' discretion, guided by the wishes of the donor settlor, which contrasts to an absolute gift that passes ownership to the recipient immediately." However, any contribution into the trust above the nil-rate band will incur an immediate 20 per cent IHT charge.
But IHT is not the only tax angle that makes discretionary trusts attractive. There are potential income tax advantages for the trust's beneficiaries, too.
Mr O'Connell says: "Trusts are broadly assessed to the higher rate of tax (currently 50 per cent, or 42.5 per cent on dividends). If income is distributed, that distribution is shown to have tax paid at 50 per cent, but in the event the recipient is a non-taxpayer - which in grandchildren's trusts is often the case - the beneficiary should be able to reclaim a significant amount of income tax paid by the trustees."
Unlike with a straightforward gift, grandparents can also retain some control over the funds once the trust has been established - for example, the person setting up the trust can appoint themselves as one of its trustees. Duncan Lawrie's Mr Barry says: "On gifting [outside of a trust], the grandparents lose control of the money - it's gone. Furthermore, once handed over, the grandparents cannot earn an income for themselves from the money."
It's this ability to generate income that further adds to the appeal of discretionary trusts. Much of the trust's funds can remain invested in various asset classes while still periodically paying out school fees. These investments can pay out an income through interest earned or dividends, which in many cases can be timed to match school fee payments.
Julie Hutchison, head of international technical insight at Standard Life, explains: "Most trusts have very flexible investment powers. A wide range of assets can be held, such as cash, stocks, shares, investment bonds, a house, and so on. The trust deed will give the trustees certain investment powers, so it's always advisable to check the deed."
There are costs associated with the administration of a trust and these will depend largely on its complexity. Any invested assets will also be subject to such charges seen in any other type of investment portfolio, and will vary depending on the amount of funds held.
There are myriad types of trust, and discretionary, as the name suggests, has no uniform rules on how the assets are handled on death. If a grandparent dies, the trust will be paid out to the beneficiaries, "but how this is done depends entirely on how the trust has been written," says Mr Barry.
For some trusts, the death of a beneficiary will trigger it to be moved to the 'next stage', at which a new beneficiary might step into the frame - but this will not necessarily mean the fund will be paid out.
Different rules also apply across Britain, explains Ms Hutchison: "Under Scots law, a trust can go on and on - there is not necessarily a fixed end point. In English law, the rules recently changed so that a new trust can last for 125 years, although shorter time periods might also apply.”
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