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Back to School Funding – grandparents get top marks

Grandparents can make a real difference to their grandchildrens’  futures by helping with the costs of education. With the cost of a 3 year university course topping £50k*, grandchildren could otherwise be faced with a sizeable debt on leaving university, or worse, could be put off going altogether.

The right combination of trust and investment wrapper can quell any concerns grandparents may have about handing large sums to their grandchildren at a young and impressionable age. An offshore bond held in a discretionary trust combines the necessary control with a tax efficient investment solution to meet education costs.

The satisfaction of giving

Many grandparents often leave money in their wills for their grandchildren. But by making that gift during their lifetime, they get to see the benefit it has on their family on many different levels:

  • They will have played their part in their grandchildren’s futures;
  • A financial burden on their own children will have been be lifted; and
  • At a personal level, they may have made IHT savings.

The amounts needed can be substantial, particularly where there are several grandchildren. Grandparents willing and able to make such a financial commitment may insist on an element of control over who benefits and when. They may also want a say in where it is invested.

Controlling’ the gift

Concerns about giving grandchildren too much too soon may rule out absolute gifts. Making the gift into a discretionary trust may ease those fears and provide grandparents with the control they seek. Discretionary trusts are typically flexible enough to allow any future grandchildren to also benefit. But they’re not able to invest in Premium Bonds and JISAs as these can’t be held in trust.

Tax efficient investment

Control within trusts normally comes at a price. Discretionary trusts, where the trustees decide how and when income and capital is distributed, pay higher rates than say a bare trust where the beneficiary’s own tax rates and allowances can be used. But with the right investment choice, that need not be the case.

Offshore Bonds: meeting Uni fees
Offshore bonds score top marks here. During the investment period, the bond suffers no UK tax on income and gains, and tax is deferred for bond owners until money is withdrawn and a chargeable event occurs.

This simplifies matters for trustees of a discretionary trust as they have no income or gains to account for during the investment term. And when university costs need to be met, policy segments can be assigned to the grandchild, who will be the person taxed on subsequent surrender.

But because they are unlikely to have much income as students, they will have unused allowances and bands to cover the profit – namely the £11k personal allowance, the starting rate band of £5k, and the new £1k Personal Savings Allowance – a potential total of £17k in all. Over a typical 3 year University course that’s £51k of chargeable gains which can be taken tax free.

Offshore Bonds: meeting school fees
If funds are needed to pay for private school fees before the child reaches 18, the trustees could cash in the required amount from the bond, but in doing so the settlors on the discretionary trust would be taxable on any gain. If the settlors are no longer around, the gain is taxed at the trust rate, currently 45%.

It’s possible to overcome this and have the gains taxed on the children if the trustees complete a deed creating an absolute interest for the child in part of the trust fund, before surrendering that part. The gain will then be assessed on the child, using the child’s allowances. Tax wise this will give the same result as assigning to an adult child.

Mutual Funds
A mutual fund portfolio held in a discretionary trust is unlikely to be as tax efficient as an offshore bond, particularly if bond profits can be extracted tax free.

This is because trustees will still have to pay tax on accumulated income at the trust rate, and possibly CGT should gains arise above the trust annual exempt amount. The same income and gains can roll-up gross if funds are held in an offshore bond wrapper.

However, if grandparents are happy that their grandchildren can access the fund at 18, there can be an advantage to making gifts under bare trust. Any resulting tax on mutual funds would be assessed on the beneficiary, using the beneficiaries’ allowances. This time, the new £5k dividend allowance, as well as the full annual CGT exemption, can be added to the allowance armoury. In this way it would be possible to take profits out of the tax net on an annual basis, providing a ‘tax free’ pot to draw on when needed.

The cost of an education

The average fee for a private day school is around £15,000 a year and boarding school is nearly twice this (Independent Schools Council Census and Annual Report 2016).

* The price of a university education in England adds up to around £54,000 for a 3 year course at an English University taking into account fees, average living and accommodation costs (Student Money Survey 2016).

With such high costs, making a gift at the earliest possible time means that investment growth can play a bigger part in meeting those costs. And from the grandparents perspective, the gift will be outside their IHT’able estate sooner.

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