Bare trusts are a simple and effective tool for grandparents who wish to make financial gifts to their minor grandchildren. And the ability to access the underlying monies prior to the child’s 18th birthday (unlike a Junior ISA say), make them a compelling choice for funding future school fees.
What is a bare trust?
A bare trust is a straightforward trust arrangement where the trustee (typically the parent or grandparent) holds assets on behalf of a beneficiary (the grandchild), who will eventually have full control over the assets once they turn 18.
Bare trusts & school fee planning
Here’s a scenario we come across regularly:
- Three Generations…
- Mum and Dad are in their 30s/40s, with young children. They’re earning well but this is also a period of peak outgoings with mortgages, childcare, etc., and they’re assessing the affordability of future private schools,
- Meanwhile, Grandma and Grandad are sat on surplus capital and are keen to help, not only to see the monies put to good use during an expensive period for their children, but also to advance their own estate planning goals (i.e. to reduce the potential inheritance tax ‘IHT’ charge on their estate).
One option here would be for the grandparents to effectively bypass the children and gift directly to the grandchildren via a Bare Trust.
Worked example
Consider the following example:
Jack and Kate have two young children, aged 5 and 7. They’re currently attending a State Primary school, but the parents are considering private secondary school from Year 7 onwards, at an anticipated cost of around £30k a year per child.
To help with the cost, and as part of his own estate planning goals, Jack’s father, Christian, is keen to gift them £300k immediately.
- Two bare trusts are established (one per grandchild) with an initial gift of £150k,
- The monies are then invested in a diversified portfolio of stocks and bonds, initially targeting capital growth as it is some years before the first withdrawal,
- Jack and Kate are appointed as trustees and therefore have control not only over the underlying investments but also any future distributions of income and capital. That is, they can access the trust monies as they wish (and before the children turn 18), as long as this is for the benefit of the underlying beneficiaries – their children. They intend to draw on the trusts to fund private secondary school,
The trusts therefore provide a highly flexible and tax efficient (see below) vehicle for investing for minor children, and funding future school fees.
Disclaimer: When investing, your capital is at risk. The value of your investment (and any income from them) can go down as well as up, and you may get back less than you invested, particularly where investing for a short timeframe (we normally recommend a horizon of at least 5 years).
Tax efficiency
One of the most appealing aspects of bare trusts is their tax efficiency.
The grandchild is the absolute owner of the assets from the outset, meaning any income or realised capital gains are assessed on them.
Income tax
Since grandchildren are likely to have little or no income of their own, they can take advantage of their personal tax allowances.
In the previous example, a £150k investment is likely to generate dividend income of around £3k a year, comfortably within the grandchild’s £12,570 Personal Allowance, hence no income tax due (and no need to file a tax return). Note, that the child will also have their Dividend Allowance (£500) available. Should the dividends exceed the child’s available allowances, they would be taxed at 8.75% to the extent they fall within the basic-rate tax band, 33.75% higher and 39.35% additional.
As a side note here, if the bare trust was established by a parent rather than grandparent, Parental Settlement Rules would apply. In that instance, if the investment income exceeded £100 a year, all of the income (not just the excess) would be assessed on the parent rather than the grandchild.
Capital gains tax
Realised capital gains are also taxed at the beneficiary’s marginal rate.
Under current rules, they would have their £3,000 annual exemption available, whereas any excess will likely incur typically 10% tax only.
Inheritance tax
Additionally, the original gift into the trust will no longer form part of the grandparent’s estate for IHT purposes, provided they survive for seven years after the gift is made.
In the previous example, this would provide a potential tax saving of £120k (£300k gift x 40% IHT rate).
Drawbacks
The main potential drawback of a bare trust is that once the grandchild reaches 18, they gain full control of the assets. For some parents or grandparents, this may be a concern, particularly if they feel the grandchild may not yet be ready to manage a significant amount of money.
But this is where the funding of private school fees can be a particularly good fit, as most, if not all, of the funds shall be spent by the time the child turns 18. A common strategy here is to estimate the present-day cost of school fees and gift that amount to the grandchildren (via bare trust) and any residual amount to the adult children.
In addition to the above, the trust will need to be registered with HMRC, which is somewhat cumbersome, to say the least.
Conclusion
Bare trusts are an effective means of gifting assets to grandchildren in a tax-efficient manner, while still allowing grandparents and/or parents to maintain control over the assets during the child’s minority. They offer simplicity, tax advantages, and a way to potentially reduce a grandparent's taxable estate for IHT.
Disclaimer: The Financial Conduct Authority does not regulate Trusts, Inheritance Tax and Estate Planning. Tax thresholds depend on your circumstances and may change in the future.