Trusts for Children – Your Options

Parents or grandparents may wish to set money aside for their children/grandchildren by way of lifetime gift.   For small sums, the money can be given to the child’s parent or guardian to invest on the child’s behalf.  However, for larger sums, a trust may be more appropriate, for reasons including:

• Control – the parent/grandparent can retain a degree of control over the trust fund by being a trustee
• Flexibility – nobody knows what the future may hold, and a flexible trust allows the trustees to take account of beneficiaries’ changing circumstances and needs
• Asset protection – most people feel that 18 is too young an age to receive a large capital sum

What are the options?

 

1. Discretionary trust:

If flexibility is the most important factor, a discretionary trust may be appropriate.  Under a discretionary trust, the trustees have complete discretion as to which beneficiary(ies) receive capital or income and as to when they receive it.  Beneficiaries may receive unequal amounts and no beneficiary has a right to either income or capital in the absence of a decision by the trustees in their favour.

As an alternative, where control and asset protection are the main concerns, children may be given fixed shares of the trust fund, but their entitlement to capital made contingent on their reaching a specified age greater than 18 (e.g., 21 or 25).   Further flexibility can be built into such trusts by giving the trustees an overriding power to alter the share each child will receive.  Trustees have wide powers to use income from a child’s share of the trust fund for his maintenance, education and benefit, while he is under the specified age (for example, to pay school fees).

 

2. Bare trust:

For smaller trust funds, where the costs of administering a trust may be disproportionate to the benefits, a bare trust may be appropriate.

A bare trust is one where the beneficiary has an immediate right to both the capital and income in the trust, but the trust fund is held on his behalf by others (trustees).  This is a common way of holding funds on behalf of a minor child.  However, when the child reaches the age of 18, he can demand that the trust fund be transferred to him (as once 18 he can give a good receipt for the money).

 

3. Disabled persons trust (DPT) – where there is a disabled beneficiary:

Special consideration must be given when there is a beneficiary who has a disability. A disabled beneficiary may be or become vulnerable if they cannot manage either own affairs. For example, if a disabled beneficiary receives a sum of money outright from an inheritance, this could risk their entitlement to means tested benefits, such as Disability Allowance. It then becomes important to determine whether is appropriate for that beneficiary to receive cash outright, or a trust structure is used to safeguard them and the assets.

A DPT operates in a very similar manner to a discretionary trust in that appointed trustees look after the money set aside for the vulnerable beneficiary (principal beneficiary) and use it for their benefit during their lifetime. They can invest the money to generate income etc, but it is at the trustees’ discretion  how to manage the trust fund.

 

Taxation of trusts

1. Bare trusts:

 

• The beneficiary is taxed on the income at his own marginal rate (a child may well be a non-taxpayer) but see NOTE below;
• Gains arising are treated as the gains of the beneficiary and he can use his own annual allowance; and
• For inheritance tax (IHT), the beneficiary is treated as owning the assets. Therefore, if he should die, the bare trust assets form part of his estate.  There is no charge to IHT when the beneficiary attains 18 and the assets are transferred to him.

 

2. Discretionary trusts and trusts subject to an age contingency:

 

• The trustees are taxed on income arising to the trust at 45% (a tax reclaim may be made if income is distributed to a beneficiary whose marginal tax rate is lower than this) – but see NOTE below
• The trustees must pay capital gains tax on gains in excess of the trust’s annual allowance at the rate of 28%. The trust annual allowance is half the individual annual allowance.
• Depending on the value of the trust fund, there may be a charge to inheritance tax (1) when capital payments are made out of the trust (for example, on a distribution of capital to a beneficiary) and (2 )on every tenth anniversary of the start of the trust. However, IHT is generally payable only if the assets of the trust exceed the ‘nil rate band’ (currently £325,000) and then only at 6% on the excess value over the nil rate band (taking account of assets paid out during the previous 10 years).

 

3. DPT:

 

• DPT’s enjoy special tax treatment if the beneficiary qualifies as a vulnerable person (disabled beneficiaries and beneficiaries under the age of 18 at least one of whose parents has died)
• Trustees of a DPT can ask for the trust’s tax on income and capital gains to be calculated as if the assets belong to the disabled beneficiary, and special more favourable tax rules apply. The rules and calculations are complex and we recommend seeking tax advice.
• For Inheritance Tax, the transfer of assets to the trust will be treated as a “Potentially Exempt Transfer” (as opposed to facing the usual immediate inheritance tax charge at 20%), meaning that inheritance tax will only be payable if the settlor dies within 7 years of the transfer. When the disabled beneficiary dies, the assets of the trust will form part of their estate for the calculation of inheritance tax, but any tax due on trust assets will be payable by the trust.

 

This is not intended to be an exhaustive guide to what is a complex area of law and readers should seek professional advice as to the appropriate form of trust for their own particular circumstances.

For further information or to make an appointment to discuss trusts for children, please contact rhw’s Wills, Trusts and Estates Team:

Paula Alvarez () or call 01483 302000