Keep control of your child's savings
After years of planning and carefully setting aside money for your child's future, handing over lots of cash can be a daunting prospect. While you may have intended the money for their education or to help them get on the property ladder, their intentions may be more geared towards fast cars and even faster living.
To give you greater control over when they receive the money, how much they receive and even whether they receive it at all, it may be worth putting a trust in place. These are legal documents that set out details such as who receives what and when, and depending on the type of trust, they can be used to facilitate and safeguard your plans.
They are commonly wrapped around investment products, such as unit trusts or shares, but can be used for just about any assets, including property, antiques or works of art. There are additional benefits to using trusts for a child's investments.
Even where the primary objective of investing is for the child's future, a trust can offer inheritance tax (IHT) planning advantages. "The IHT nil-rate band is shrinking in real terms and asset values continue to shoot up," says Paul Wilcox, chairman and technical director of Way Group. "This makes IHT a permanent and negative feature of modern life."
A further benefit of using a trust, rather than saving up for a child in your own name, is how the money is viewed if you should go bankrupt or end up in a messy divorce. If you were involved in a situation where your assets could be split, anything held in trust would be regarded as outside your estate and so would be protected from any creditors or a claim from another person.
Several different trusts exist, from the very simple bare trust that offers tax benefits, but doesn't afford much control to more complicated arrangements where you can determine exactly who receives what and when. The one that's right for you and your financial requirements will depend on what you want to achieve and the amount of money involved.
While trusts generally give you more control over the money you want to give to a child, with the most basic type of trust - the bare or absolute trust - this isn't strictly the case. Rather than allowing you to determine when they receive the money, these ensure the child has an automatic right to the money when they reach 18.
While this might not seem ideal, the beauty is that these trusts allow you to put an investment in the child's name for tax purposes. Without one, because you have to be at least 18 to hold an equity-based investment, you could only put money in investments such as unit trusts, open-ended investment ompanies (OEICs) and investment trusts in your own name, even if the money is intended for the child.
Holding it in your name means it would be treated as yours for income and capital gains tax purposes. Additionally, if you died, it would be included within your estate and may also be liable to IHT.
Placing money in a bare trust creates a potentially exempt transfer. So, providing you live for a further seven years, it will be automatically outside your estate for IHT purposes.
Additionally, any income or capital gains the investment earns will be treated as the child's. The exception to this is if the money is for your son or daughter and it generates more than £100 of interest. Then it will fall foul of the taxman's rule on parental income and all income it generates will be treated as yours for tax purposes.
"Bare trusts are useful, as gifts into them are still considered potentially exempt transfers, so they can be unlimited in size, but the downside is that they are absolute and the trustees cannot divert the assets or change the proportions going to different beneficiaries, nor can they deny any beneficiaries or add new ones," adds Wilcox.
For more control, it's worth considering a discretionary trust or one of its variants. These allow you to vary the beneficiaries and what they receive. For example, if you set up a trust for your grandchildren, you could leave it flexible enough to include any that might arrive after you've set up the trust.
There are a number of variations on the straightforward flexible discretionary trust model. One of these is the accumulation and maintenance trust, although it is increasingly being superseded by the 'age 18-25' trust.With these, the income can be used for the maintenance of the beneficiaries until they reach an age, not more than 25, when they become entitled to at least the income from the trust, if not the assets, too.
Another variant is the interest in possession trust. With these the beneficiary is entitled to income from the trust, but doesn't have an automatic right to the assets. This means you could use one to pay a child's school fees then pass the assets to another person.
The downside with all the variants of the discretionary trust is the tax treatment. Unimpressed with the amount of tax people were saving by setting up trusts, in the 2006 Budget, then-Chancellor Gordon Brown extended the tax treatment of discretionary trusts to all its variants.
This means that there is an automatic charge of 20% of anything placed in the trust in excess of the IHT nil-rate band (£300,000 in 2007/08), followed by a 10-yearly charge of up to 6% on any excess. One way around this is to set up trusts for less than the IHT nil-rate band, because unless investment growth significantly outpaces the rise in the nil-rate band, they will not be subject to these tax charges.
Arranging a trust
Although they offer the benefits of greater control over how your child's investment is handled, arranging a trust doesn't have to be complicated. For the simpler bare or absolute trust you will usually be offered a form that enables you to place the trust around the investment when you take it out. Generally, this service will be free.
Even the more complicated trusts can be organised through the investment company. For example, the Children's Mutual provides details of discretionary trusts as well as bare trusts, with each only needing a simple form to be completed to set one up.
If your requirements are more complex, or you have a mixture of investments to pass on to children, or a considerable sum is involved, you should consider legal advice. A solicitor or estate planner will be able to recommend the most suitable trust for you and draw up the appropriate legal document. Details of legal professionals who can help with your trust arrangements can be obtained from the Society of Trust and Estate Practitioners (STEP).
Whether you do it yourself or call in the professionals, you will need to appoint trustees. Their responsibility is to look after the assets for the beneficiary or beneficiaries of the trust.
You can have between one and three trustees - and you might want to include yourself as one of these, as well as a friend or relative who will look after the children's interests if you were not around. You can also employ professional trustees, although they will charge for their time so may only be worth considering if a large amount of money is involved.
Also, it's prudent to regularly review your trust arrangements. They're not one of the government's favourite planning tools, and already there have been moves to make them less appealing. Regular checks will make sure you're not caught by any rule changes and you're taking full advantage of the rules that are in place.
Open-ended investment companies are hybrid investment funds that have some of the features of an investment trust and some of a unit trust. Like an investment trust, an Oeic issues shares but, unlike an investment trust which has a fixed number of shares in issue, like a unit trust, the fund manager of an Oeic can create and redeem (buy back and cancel) shares subject to demand, so new shares are created for investors who want to buy and the Oeic buys back shares from investors who want to sell. Also, Oeic pricing is easier to understand than unit trusts as Oeics only have one price to buy or sell (unit trusts have one price to buy the unit and another lower price when selling it back to the fund).
The tax levied on the total value of your estate after you die. IHT has to be paid by the beneficiaries of your estate before they can receive any of the money from it. The money can’t be taken from the value of the estate _– it has to be paid before any money can be released. There is an IHT threshold – known as the “nil-rate band” – below which no tax is levied (£325,000 in 2011/12). Any amount above the nil-rate band is subject to tax at 40%. If your estate totals £600,000, there is no tax on the first £325,000; however your estate will pay 40% tax on the remaining £275,000, a total of £110,000. Prudent tax planning can reduce your IHT liability, so always consult a specialist solicitor.
Everything you own: all your assets (property, cars, investments, savings, insurance payouts, artwork, furniture etc) minus any liabilities (debts, current bills, payments still owed on assets like cars and houses, credit card balances and other outstanding loans). When you’re alive this is called your wealth; when you’re dead, it becomes your estate.
Capital gains tax
If you buy an asset – shares, a second home, arts and antiques – and then sell it at a later date and make a profit, that profit could be subject to CGT. You don’t pay CGT on selling your main home (which is why MPs “flipped” theirs so regularly) or any securities sheltered in an ISA. Individuals get an annual CGT allowance (£10,600 in 2010/2011) but if you have substantial assets it’s worth paying an accountant to sort it for you.
This is more usually a feature of car insurance but it can also crop up in contents, mobile phone and pet insurance policies. An excess is the amount of money you have to pay before the insurance company starts paying out. The excess makes up the first part of a claim, so if your excess is £100 and your claim is for £500, you would pay the first £100 and the insurer the remaining £400. Many online insures let you set your own excess, but the lower the excess, the more expensive the premium will be.