Life insurance can be a very useful wealth transfer tool, providing several benefits around tax-efficiency and control - it need not be the preserve of only the ultra-wealthy.
Charles Calkin, Partner and Financial Planner at James Hambro & Partners, explains why passing money to grandchildren through a bare trust provides a neat solution to many of the problems associated with substantial intergenerational gifts.
Many older investors want to pass money to their grandchildren to help fund their education and set them up for adult life. Bare trusts can be a great help for those who want to make significant gifts but who are also concerned about minimising tax and protecting family wealth from divorce.
A bare trust overcomes a number of problems you might encounter when making substantial gifts. Children cannot own shares except through a Junior ISA (JISA) or a pension, which have to be opened by a parent or guardian and come with limitations. You can only invest £4,368 (2019/20) into a JISA each year and the money is locked in till the child reaches 18. At this point they can take control of it and splash the cash (or leave it to automatically convert into an adult ISA). You can invest £3,600 (£2,880 net of basic rate tax relief) a year into a pension for a child, but then the money is locked up even longer – till they are at least 55 by today’s rules.
The alternative is to give the money to the parents to invest or use at their discretion, but the assets are in their name and you may be passing them a bill too. Any income or realised capital gains are assessed to them for tax purposes, potentially adding to their own tax costs.
I meet many clients who fret about giving away money they worked hard to save or that they themselves inherited only to see half of it disappear out of the family hands as part of a divorce settlement
There is another problem with gifting through parents – what happens if your son or daughter divorces? I meet many clients who fret about giving away money they worked hard to save or that they themselves inherited only to see half of it disappear out of the family hands as part of a divorce settlement. This is, perhaps, where the bare trust comes in most useful.
A bare trust is a legal arrangement that allows you to transfer assets to your grandchild’s parents (the trustees) to hold for his or her (the beneficiary’s) benefit until he or she reaches 18 (or 16 in Scotland). At this point they are absolutely entitled to the assets without any conditions.
A bare trust is easily set up. There are no specific formalities unless land is involved. We have done them for many clients. Your gifts are then registered through an account, usually set up by the parents in their name and designated with the child’s initials. You could, if you wished, run the bare trust account for a grandchild yourself or get your wealth manager to manage the money.
You want to be sure you have put the asset out of reach of a parent on divorce, creditors on bankruptcy or other family members on death
Whatever arrangement you come to, it is worth taking appropriate legal advice so that the documentation around the trust and its terms cannot be challenged and held void. You want to be sure you have put the asset out of reach of a parent on divorce, creditors on bankruptcy or other family members on death.
Once set up, assets held in the bare trust are counted against the child’s own income tax and capital gains tax allowances (not yours or their parents’), meaning a gift of as much as £200,000 could enjoy tax-free growth.
Funds must be used for the child’s benefit. This might include paying school or university fees and covering costs like uniforms, music lessons and expensive school trips. When the child reaches 18, he or she has the right to take control of the money, hopefully putting it towards something useful like a house deposit. In the event of their parents divorcing the money in the trust is ring-fenced and remains the child’s.
Helping family in the most sensible and tax-efficient way is something that drives the longer-term thinking of many of our users. This is an area wealth management advisers are particularly used to working in. To find the right expert to maximise family wealth and protect it from risks, try our 2 minute online matching tool.
There are no limits as to how much you can put in a bare trust, which is useful if you are looking to reduce the inheritance tax (IHT) liabilities on your estate.
In simple terms, you (and your spouse or civil partner) can each give a total of £3,000 a year that is IHT exempt. If you have not given anything in the previous tax year you can carry forward unused allowances for one year. This doesn’t include normal Christmas and birthday presents, or wedding presents (you can give up to £2,500 to each grandchild and £5,000 to each child as a wedding present).
Most other gifts above this would be considered “Potentially Exempt Transfers”. These are free from IHT if you survive seven years. If you survive between three and seven years, the IHT liability may be judged on a sliding scale. But there is also a useful and under-used IHT exemption, called the “normal expenditure rule”, which allows you to make gifts out of your after-tax income as part of your normal spending plans.
There is also a useful and under-used IHT exemption, called the “normal expenditure rule”, which allows you to make gifts out of your after-tax income as part of your normal spending plans
There are no limits to how much you can give this way, but you have to demonstrate that you can afford to sacrifice this income and that it does not lead to a demonstrable reduction in your standard of living. Giving regularly is the best way of showing this.
Surveys show that IHT is the most unpopular tax there is. Many people resent paying 40% or more on their income and then being taxed 40% on much of what is left unspent on death. This resentment can lead to people giving away too much too soon. I always remind clients that we do not know how long we will live or how much care we will need in later life. Using the normal expenditure rule and gifting regularly can be a safer strategy. You do not need to do anything rash and it can be reviewed easily if circumstances change.
If the money you gift to your grandchildren through the bare trust is being invested it is also a good way of enjoying the benefits of “pound cost averaging”. This is where money is drip fed into the markets regularly so that you avoid the possibility of investing a big lump sum right at the top of the market.
If the money you gift to your grandchildren through the bare trust is being invested it is also a good way of enjoying the benefits of “pound cost averaging”
Parents might ask if it is possible to put their own money into a bare trust for their child. That is more complex. HMRC is keen to avoid couples using bare trusts as a tax avoidance loophole. If they put their money into a bare trust for a child, it can only earn £100 in income in a year. If the interest or dividends exceed £100 – even by just one pound – then every penny of income is counted as the parents’ for tax purposes. It usually makes sense to put parental money into a JISA and grandparents’ money into a bare trust.
We are always happy to help existing clients – and potential new clients – to manage and gift money effectively. And do remember that IHT rules are complex and subject to change, so it is worth seeing an adviser and reviewing your strategy regularly.