Child Taxation: 4. Investing For Grandchildren

We know that children must pay income taxes and capital gains taxes in the same way and that children also have full personal income tax and capital gains tax allowances and that filing self assessment income and capital gains tax returns must be done in the same way unless the income and gains falls with tax free personal and capital gains tax allowances.

It is important to not forget that children and grandchildren are entitled to a personal allowance and an annual CGT exemption and where gifts are made, if income exceeds £100pa it may be taxed on the parent.  This even applies to trusts where if an absolute or bare trust was established before 9 March 1999, the £100 rule does not apply but if the trust is established after 9 March 1999, the £100 income rule will apply.  For capital gains tax within a bare trust, any gains are always taxed on the child and not on the person making the wealth transfer/gift.

Grandchildren – Three Trusts To Consider

Let’s bring in the grandparents.  If you are a grandparent, you can set up various types of trust for your grandchildren.

1.  Grandparents Discretionary Trust

Usually, this would not be in a particular child’s name as beneficiary but a “squad” of potential beneficiaries e.g.  “Smith Family Trust”.  Income from the trust may be paid to the parent for a grandchild’s maintenance, education or other requirement and the income will be taxable on the child i.e.  hopefully below personal allowances so no taxes are due.  That said, real trust allowances and the higher trust tax rates apply to the trust on income/gains into to the trust rather than personal tax rates.  The trust’s own personal tax allowance is just £1,000pa (rather than £12,570pa) and income tax rate at 45% only and dividend income tax at 38.1%.  When using discretionary trusts we would more likely use investments inside the trust that generate growth rather then income to avoid the 45% tax charge or 38.1% dividend tax.

2.  Grandparents Flexible/Interest in Possession Trust

Think of this like having a football team squad or a rugby team squad.  The same principle of having a beneficiary “squad” of potential beneficiaries e.g.  “Our Grandchildren” but then a named “team line up for tonight’s match” i.e.  the specific grandchild is in the squad but also named in the team line up and entitled whilst they are ‘still on the pitch’, all income due will be assessed for tax on that named grandchild.  This differs significantly to the discretionary trust in avoiding those higher tax charges above and assessed full on the child.

3.  Grandparents Bare/Absolute Trust

Using an absolute trust (child beneficiary names cannot be changed), capital gains for the trust would attract the child’s full capital gains tax annual exemption whereas the discretionary and flexible trusts above would be subject to the Trust’s own capital gains tax annual exemption (currently £6,150pa rather than personal capital gains tax exemption £12,500pa).

For all trusts we would tend to lean towards using insurance investments bonds inside the trust as they produce no income, removing one element of taxation.  It is the chargeable gain that may become taxable and then only on the grandchild.  For example, grandparents establish an absolute trust for the grandchild.  At age 18 years, the grandchild goes off to university or needs a car or house deposit etc.  The onshore (UK based) bond is encashed (or partially encashed).  The trust is taxable on the child and provided no chargeable event limits are triggered e.g.  no more than 5% pa rolled up over the years invested or the per annum growth/profit (known as the slice), when added to the child/student’s earned and other savings income, provided it does not take them into the higher rate tax bracket (40%), then no tax is payable.

You may also wish to consider offshore bonds to utilise offshore tax free growth.  When the personal allowance £13,570 is added to the £5,000 savings allowance, the child could encash up to £18,570 in gains alone (so they might be encashing £60,000 of which £18,570 is profit/gains and pay no tax.

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