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Educating Grandchildren - An Inheritance Tax Planning Opportunity

Educating Grandchildren - An Inheritance Tax Planning Opportunity

Educating Grandchildren - An Inheritance Tax Planning Opportunity

Date: September 25, 2018

Grandparents are playing an increasing role in the lives of grandchildren from providing early years childcare services to supporting education costs. With students leaving University with spiralling debt, there is a way that a grandparent can help support those costs and mitigate Inheritance Tax (IHT) at the same time.  

Grandparents may wish to set money aside for their grandchildren by way of lifetime gifts.  An individual can gift £3,000 per year (or £6,000 if they have not utilised their allowance in the previous tax year) without this being brought back into the Inheritance tax calculation if the donor were to pass away within 7 years of the gift. If Inheritance tax is applicable to a person’s estate, then each year a £3,000 gift is made, a IHT saving of £1,200 is gained.

In circumstances where a significant IHT liability is anticipated, the £1,200 saving may be but a drop in the ocean, but establishing a pattern of annually utilising this exemption as part of a longer term strategy can play a greater role in mitigating IHT, and builds a sizeable nest egg for grandchildren higher education costs.

If you established an annual saving when a grandchild child was born, in year one you could gift £6,000 and then each subsequent year £3,000, totalling £57,000 by the time the grandchild reached 18 and a IHT saving of £22,800 (40%)  Without even factoring in investment growth, this could make a real difference to the debt a grandchild leaves university.  

If both grandparents were able to utilise their respective allowance then this figure could increase appropriately and of course could be divisible across all the grandchildren. It would not be £3,000 per grandchild per year but in total.

One of the drawbacks of gifting the £3,000 directly to an account in the grandchild’s name is that the money belongs to the child and once they reach 18 all control has been relinquished. A grandchild at that age, or their friends influencing them, may not appreciate the financial position they find themselves in and make unsound financial decisions like that hot hatch, luxury holiday or gap year which may not match your intention.

If retaining control and flexibility over what the money can be utilised for is appealing, a discretionary trust may be appropriate where the grandchild (or grandchildren) are the beneficiaries and the grandparents, parents or a mixture of both are the trustees. 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. Additional beneficiaries can be added so if new grandchildren or step grandchildren arrived they could be added after establishment.

The trustees can also control what the fund is utilised for so if there are changes to higher education costs, alternative vocational courses sought or other, the fund could be utilised for anything considered appropriate such as helping grandchildren get on the property ladder, buy a car for commuting or even simply start them on the path to their own saving and investing. The trust would allow complete flexibility.

 

Taxation (2018/2019 rates)

  • The first £1,000 worth of income is taxed at normal tax rates (20% or dividend income 7.5%) Any income in addition to this is taxed at 45% (38.1% for dividends) A tax reclaim may be made if income is distributed to a beneficiary whose marginal tax rate is lower than this.
  • The normal tax-free annual income allowance of £11,850, the £1,000 annual personal savings allowance and £2,000 annual dividend allowance do not apply to trusts, so holding income producing assets can be very expensive for trustees.
  • Capital gains tax also applies to trusts, with the tax-free threshold set at half of an individual's - £5,650 in the 2017/18 tax year. Gains above this amount are taxed at 20 per cent or 28 per cent for residential property
  • A discretionary trust has a 10-yearly anniversary IHT potential liability if it exceeds the IHT threshold in force at that date (currently £325,000) In consideration of the annual allowance being utilised to establish a fund, this is unlikely to apply.

The choice of investment product utilised for the trust fund can often mitigate the implication of both or one of the lifetime taxes and we would always recommend that appropriate financial advice was obtained in relation to this. We are happy to signpost our clients to experienced, trusted advisers should this be required.

Increasingly we are finding that our clients are establishing trusts for grandchildren as part of their overall IHT mitigation strategy. The low annual gift can be comfortable to afford without a sizeable dent on a capital portfolio initially, and can also be toped up with regular gifts out of surplus income if desired. If larger gifts applicable to the 7 year rule (PETS) have already been made, the use of the annual exemption can continue to chip away at potential IHT liabilities in addition meaning ultimately, more wealth can be preserved for the family rather than the tax man.

As with any generic advice, you should always seek professional advice for your own particular circumstances and our trusted estate planning team at Coles Solicitors are happy to discuss Inheritance tax planning with you. With members of STEP (www.step.org) and SFE (www.sfe.legal ) found across our network of offices, including York, Harrogate, Northallerton and Stockton, you can start the journey to tailor made advice wherever you see our sign. Call 0800 1601010, visit www.coles-law.co.uk or pop into your local branch to start your estate planning journey with us today.