These days, school, college or university fees can really mount up. It is not unusual for grandparents to want to help out in some way. What you may not know is that there may be some tax savings, or unintended tax consequences, of providing such help.
Small amounts paid here and there, say for a school trip, may be covered by the Inheritance Tax (IHT) small gifts exemption, which exempts gift up to £250 per year, per recipient/beneficiary of the gift. Larger payments, maybe for say a school holiday, extra-curricular lessons, or holiday club, which exceed £250 in a year, may be covered by the £3,000 IHT annual exemption.
Regular gifts, if made out of surplus income, may also qualify for relief from IHT.
Any gifts made to individuals are treated as Potentially Exempt Transfers (PETs). These gifts will fall out of the charge to IHT if you survive seven years from the date of the gift.
Gifts of cash do not have any Capital Gains Tax (CGT) or Income Tax (IT) consequences. Therefore, these can be tax efficient ways of grandparents helping out, easing the burden for parents, whilst potentially reducing the amount of the grandparent’s estate that will be chargeable to IHT.
The use of a Trust
If you expect to pay out substantial amounts towards school or university fees over the life of your grandchild’s education or want to be able to set aside an amount upfront, which can be used to pay towards those fees, then a Trust may be a good idea. Trusts for school fees are often set up as Discretionary Trusts, giving the Trustees discretion over who can benefit and when. To the extent that there are funds remaining in the Trust when the grandchildren have completed their education, the Trustees can consider appointing these out to the beneficiaries absolutely. Alternatively, they may decide to retain the assets in Trust, protecting them from future events for the beneficiary, such as divorce, bankruptcy or another change in personal circumstances.
For example, take two grandparents, who each gift £325,000 in cash to a discretionary Trust (“The grandchildren’s Trust). The Trust now holds £650,000 in cash. Assuming that each grandparent has not made chargeable transfers for IHT purposes in the previous seven years, then they should have their full IHT Nil Rate Band (NRB) of £325,000 available. In this case, the IHT payable on the creation of the Trust is £0.
If the grandparents both survive seven years then the gift will drop out for the purposes of calculating their IHT position on death, meaning no IHT is payable by the Estate on the gift of £650,000. There is also the possibility of getting a second bite of the cherry. The two grandparents, seven years and one day after their initial gift of £650,000, gift another £650,000. If we assume the NRB is still £325,000 and is fully available against the gift, then no IHT will be payable on this additional £650,000 at the time it is gifted to the Trust. If the grandparents survive another seven years, then this second gift will also drop out of their Estates and no IHT will be payable on their deaths.
The Trust itself will fall within the relevant property regime, meaning it will have chargeable events for IHT purposes, on which some IHT may be payable. However those events, which arise every 10 years, or when capital (not income) is distributed from the Trust, are at significantly lower tax rates than the potential 40% charge on death, meaning the IHT is spread over a whole generation rather than as a one off hit on death.
Trusts are a complex area, and can incur compliance costs on Tax Returns, possible Trust accounts, and periodic IHT Returns. Our Private Client Tax team can advise you on your specific circumstances, ensuring you understand all of the tax implications before proceeding.
