Rebecca Williams, client director at wealth manager Brown Shipley, explains why bare trusts can be a useful option for grandparents wishing to help fund their grandchildren’s education and how bare trusts enable clients to achieve their goals in supporting the next generation’s educational needs.
Many parents highly value the ability to privately educate their children, but the ever-increasing costs can prove hugely expensive over the years.
Parents can expect to pay approximately £275,000 (assuming costs of £15,000 per child per annum inflating by 4% from age 4 to 18) for a private education for a single child from four to 18 years old, with this price increasing significantly if the child is boarding. Children that do not go to a private school, but go on to university can also build up significant debt from a combination of tuition fees and living costs over the duration of their studies.
This is often where grandparents come in, as many are 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 is an effective alternative worth considering in such cases – the bare trust.
Tax friendly trust
The word ‘trust’ can ring alarm bells. They are often regarded as complex, costly and involving considerable ongoing administration.
However, 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 will act as a default bare trust. This account can then pay school or university fees directly.
The big advantage of a bare trust is their tax treatment. The money inside a bare trust is treated as if it belongs to the child for tax purposes. Grandchildren can use their own personal income tax allowance, personal savings allowance, capital gains tax exemption and dividend allowance each year in such cases.
In the new 2018/19 tax year this could allow an income of £19,850 to be generated in the trust before any income tax is payable (assuming the grandchild has no other income). Therefore, this provides a very tax efficient option for some clients.
In terms of upkeep, if the grandchild has no other income and income and capital gains generated within the trust are within their personal allowance, they should not need to complete a tax return form. In comparison to a discretionary trust, a bare trust is more straightforward, cost effective and involves less administration.
Equally, there are also no immediate tax implications for a grandparent making a cash gift into a bare trust.
When a person makes a gift to a bare trust it is considered a ‘potentially exempt transfer’ (PET). This means that they must survive seven years from the date of making the gift before it is outside of their estate for inheritance tax (IHT) purposes. If the grandparent dies before the grandchild is 18, the money in the trust is unaffected and school fees can continue to be paid.
Another point to note is that while the child is under the age of 18 grandparents can control, in conjunction with parents, the money in each trust. Money in a bare trust account is invested in line with the grandparents’ and parents’ attitude to investment risk, and clients can control the investment strategy and manage the payment of school fees accordingly.
A common objection to bare trusts is that the grandchild becomes absolutely entitled to any money or investment remaining in the trust at the age of 18, with some grandparents baulking at the thought of giving a young person access to such large sums of money.
However, if the costs are known or can be estimated at outset, then 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, at this point, it would ultimately be their own decision.
It is also worth noting that any 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. If the grandparent dies within seven years of making the gift to the bare trust there may be IHT to pay. The amount of IHT 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.
It is also important to highlight that this type of planning only works for grandparents, and is not suitable for parents. This is due to anti-avoidance rules meaning there are no tax advantages to parents gifting money via a bare trust.
In terms of administration, 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.
Long term financial viability
Before making significant gifts of capital, grandparents should always ensure they have planned adequately for their own long term financial security.
A cash flow plan would be advantageous here enabling them to look at income, assets and the affordability of gifts. Once all these factors have been taken into account it would be possible to determine whether a bare trust is the right choice for the client, ensuring they still have sufficient funds to maintain their desired lifestyle in retirement.
By evaluating alternative options such as the bare trust, clients can achieve the most efficient outcome when it comes to funding the next generation’s education.
Rebecca joined Brown Shipley in October 2015; she provides advice on risk management, investments, retirement solutions, estate planning and lifetime cash flow planning. Rebecca has particular experience of using lifetime cash flow with clients to help structure their affairs tax efficiently and plan to meet future goals. Rebecca is a Chartered and Certified Financial Planner, a Fellow of the Personal Finance Society and the Chartered Institute for Securities and Investments. Rebecca also holds the Society of Trust and Estate Planners Certificate.