Rising property prices and the increasing cost of further education mean that today’s young adults face a much greater financial hill to climb than previous generations. And increasingly it’s grandparents who are coming to the rescue.
The Council of Mortgage Lenders* suggest that the proportion of first time buyers getting help from parents or grandparents has risen from around 30% in 2005 to more than 50% in 2014.
Sharing wealth between generations not only helps grandchildren pay off student debt or get a foothold on the property ladder, it can also help to reduce grandparents’ IHT liability.
But thought needs to be given on the best way to pass on wealth and how to hold and invest it until it’s needed.
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.
Grandparents may insist on an element of control over who benefits from their gift and when. They may also want to say where it’s invested.
‘Controlling’ the gift
There may be an understandable concern about giving grandchildren too much too soon. Grandparents may want to have some control over when money is handed over.
‘Designated accounts’ have been a way of earmarking money for a grandchild without them actually receiving it. Funds can then be transferred to the grandchild at the appropriate time.
The downside to this is that income and gains continue to be assessable upon the grandparent unless the designation is irrevocable. The opportunity to use the grandchild’s income tax and CGT allowances would be missed and the asset remains in the grandparent’s estate for IHT.
Making a gift into trust instead may ease the fears of giving large sums to grandchildren before they have sufficient financial maturity and provide grandparents with the control they seek.
What type of trust?
Absolute (Bare) trusts, including irrevocable designated accounts, are the simplest form of trust. But they’re also the most restrictive. The beneficiaries cannot be amended if circumstances change and they could demand the trustees hand over the money once they reach 18.
But there are tax advantages of using absolute trusts. The initial gift is a potentially exempt transfer with no immediate IHT. Income and gains will be assessed upon the beneficiary meaning they’ll be able to use their own allowances and tax rates. And the gift will be outside the grandparent’s estate for IHT after 7 years.
Discretionary trusts provide greater control over when and how money is distributed and they’re typically flexible enough to allow any future grandchildren to benefit.
In contrast to the absolute trust, the initial gift is a chargeable transfer, but there will be no immediate 20% IHT charge payable provided the grandparents have enough nil rate band available. This means a joint gift of up to £650,000 can be made without a charge.
Control within trusts normally comes at a price. Discretionary trusts pay income tax at the trust rate of 45% (38.1% for dividends) and CGT at 20% with a lower annual allowance too. But with the right investment wrapper, that need not be the case. For example, 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 the money is needed, policy segments can be assigned to the grandchild once they’re over 18, who will then become the person taxed on subsequent surrender.
Average first time buyer deposits have doubled in the last 10 years. And today’s first time buyers can expect to need a deposit of more than £33,000 according to the Halifax.
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 grandparent’s perspective, the gift will be outside their estate for IHT sooner.
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.
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