‘Should I set up a trust for my children?’
‘I’ve heard people talk about setting up a trust for their children but I don’t understand what they are and their benefits. Can you help?’
When you hear the word ‘trust’ you may think of the super wealthy passing their money onto their children.
This is partly true. They do allow wealth to be transferred in a controlled way because the person giving the money can set out the terms or rules of when and how the money can be used by the beneficiaries.
However, they are not solely the preserve of the very rich. They can be useful for anyone who wants to hand money down and retain an element of control.
In simple terms, an individual (settlor) pays money into the trust and the trustees look after the assets for the beneficiaries.
Whether they are right for you will depend on what it is you’re trying to achieve.
If your aim is to generate a fund for when your child reaches 18, to help them with university fees or to buy a house, a trust could be a complex and expensive option compared to a junior ISA, according to Martin Jarvis, associate consultant at Mattioli Wood.
“A junior ISA structure allows tax-free growth, a regular annual investment allowance, tax free gains and tax-free withdrawals from age 18. However, if you wish to retain control, the Junior ISA may not be the product of choice as the child gains control of the fund at age 16 albeit they can’t withdraw funds for another 2 years,” says Jarvis.
If control is the key, or income is needed now – to pay for school fees, for example, then a trust could be the best option. However, the more control you gain, the more complex – and costly – the trust can become.
There is no limit on the amount that can be placed into a trust (but you should consider the effect of the inheritance tax nil rate band, currently £325,000), meaning large sums can be ring-fenced for the beneficiaries, without granting them free access.
Here, Jarvis runs through the types of trust:
Two of the most common types of trusts are ‘absolute’ and ‘discretionary’ trusts. As the name suggests, an absolute trust provides an absolute benefit for the beneficiary. This means that once the child reaches age 18 (16 in Scotland), they legally own the trust assets outright and can force their rights under the trust to gain access, if needed. An important additional consideration exists where the trust is created by a parent as there are rules in place which will assess the income and gains yielded in such trusts as being directly received by the parent(s).
A discretionary trust on the other hand, allows only for the potential to benefit and it is the trustees who decide when and to what extent a beneficiary may receive funds.
On the face of it, greater control via a discretionary trust makes it a preferable choice. However, there are further considerations to take into account in return for this extra flexibility.
There are no ongoing IHT charges payable on an absolute trust, and any gains or income held will be based upon the beneficiary’s tax rate. Therefore, its likely little tax will be due, since minors typically won’t have alternative income streams.
However, if a discretionary trust is used, then there is the potential for further tax charges to consider. These can be negated through appropriate planning; however, the calculations still need to be completed, creating greater ongoing administration.
No matter which trust you chose a key consideration is who to appoint as trustees. If the trust is for the benefit of a child, then the parent may well wish to be appointed as a trustee for control purposes. However, it is also common for further trustees to be appointed in case of death. It may well be useful to appoint an independent trustee such as a professional trustee company.
Ultimately, there is a trade-off between simplicity and control. If control is the main driver, then further planning is needed to ensure the trust maximises its effectiveness while legitimately minimising avoidable tax exposure. In other cases, an absolute trust may be better suited if funds are to be used regularly, and, again, further planning is needed around the overall trust strategy (timing of paying school fees, etc.).
Overall, there are many structures that can support generating wealth for a child, and trusts can be a very flexible method of doing so. However, it is important to be clear on what you are trying to achieve and to speak to legal, tax and financial planning experts to ensure the most effective and straightforward solution for your circumstances.