When the subject of inheritance tax is raised, commentators often reprise the quip made by former chancellor Roy Jenkins. He described IHT as a “voluntary levy paid by those who distrust their heirs more than they dislike the Inland Revenue”.
For some of my clients there is a kernel of truth in this. They want to cascade their wealth down the generations tax-efficiently, but they fear passing it to a son or daughter only for a feckless partner to pocket half the money in a settlement on separation.
I have one client who earmarked £100,000 each for her five grandchildren. Though she likes her children’s partners, she was anxious that if the parents separated the money would get enmeshed in the untangling of finances and the grandchildren would miss out.
Giving money to the parents to invest and use at their discretion presents an additional problem. The assets are held in the parents’ names — any income and realised capital gains are assessed to the parents for tax purposes.
Challenges of giving
Giving money directly to grandchildren can be challenging. Children cannot own shares, except through a Junior Isa (Jisa) or pension. You can pay up to £9,000 a year into a Jisa and they take control of the money when they are 18. You can invest up to £2,880 in a pension (which amounts to £3,600 including the 20 per cent tax relief that’s automatically added to pension contributions), but they won’t see it till they are in their 50s, 60s or later as retirement ages are pushed back.
Though anyone may make contributions to pensions and Jisas, only a parent or legal guardian can open and manage an account before the intended recipient reaches adulthood.
Bare trusts offer a solution to some of these issues. They are a simple legal structures where the parents hold the assets as trustees for their child as beneficiary. The assets are registered through an account set up by the parents in their names and designated for their child. The money is ringfenced from any divorce settlement and the child can take advantage of their own income tax and capital gains tax allowances.
A financial adviser or solicitor can set up a bare trust relatively easily and can be created for each grandchild. This means each child has their own earmarked pot, which avoids the risk you might get with a pooled trust where most of the money can be blown on one grandchild (usually the eldest), leaving little else for the others.
The beneficiary of these trusts becomes entitled to the money at 18 years old, but it can be accessed by parents earlier to help pay for things like school fees, school trips, music lessons and instruments and computers. That is a comforting safety net for mum and dad and an advantage over Jisas, which cannot be accessed before age 18.
I have known cases where children are settled into a private school and the main breadwinner is unexpectedly made redundant. Being able to draw on a bare trust at that point has been hugely helpful, enabling existing schooling arrangements to continue.
I always warn those looking to reduce their IHT liabilities not to give away too much too soon in case they need the money themselves in later life. With a bare trust, you can start with a decent but easily affordable initial gift for each grandchild, setting the seven-year clock ticking. These gifts are free of IHT if you survive seven years. Being prudent initially also ensures you have money to spare if more grandchildren arrive unexpectedly later.
Once the bare trust is established you can make further contributions whenever you like. You can give a total of £3,000 worth of gifts each tax year without them being added to the value of your estate for IHT purposes if you die within seven years. That can be to one person or split between several.
The separate small gift allowance enables you to give as many gifts of up to £250 per person as you want each year, providing you’ve not used another allowance on them.
These rules apply to each individual — so the allowances are effectively doubled for couples. Also check out the underused “normal expenditure out of income” rules. These allow you to make unlimited gifts out of taxable income if you can show this is surplus to your needs.
I have many older clients with generous final salary pension schemes that pay out more than they need day by day. By opening an account for the surplus and from there making regular direct debits into the grandchildren’s bare trust accounts, they make it evident to the Inland Revenue that this is clearly excess income. Others do it with unneeded state pensions.
One of the best examples I have seen of a grandparent using a bare trust was an old friend who began with £50 a month for each grandchild. Whenever there was a privatisation, he made an application for each of them and added the proceeds to the pot, with occasional extra lump sums. The money was smartly invested.
By the time his grandchildren became adults the pots had grown substantially. Gradually shifting the money into Isas after age 18, the adult grandchildren protected the growth from HMRC. By their late 20s each had enough for a 30 per cent deposit on a house, allowing them not only to get on the housing ladder, but also to enjoy the best mortgage rates.
A question of trust
Of course, if you distrust your children or their choice of partners, can you trust your grandchildren?
I recommend engaging with your children and grandchildren in the management of any money intended for them. Discuss how you envisage it being spent. Explore what their dreams for it might be. Involve them in conversations about how it should be invested, too.
I have not yet had a client come in and sob that their grandchild turning 18 has splashed the cash on a sports car or a long, drug-fuelled holiday in Ibiza. But I have had parents insist that they won’t accept the grandparents’ offer because it is “capitalist money” and doesn’t fit their own socialist principles. This has left the grandparents — who were probably expecting a thank you — very hurt.
In the season of goodwill and generosity, it is a reminder of the emotions tied up in giving. Maybe Roy Jenkins had a point. Even bare trusts can’t address all the complex issues of distrust that lie within some families.
Charles Calkin is a financial planner at wealth manager James Hambro & Partners