Trusts are not simply the preserve of the wealthy, but are also commonly used by families of relatively modest means looking to make provision for their loved ones, either now or in the future.
In particular, the trust can be a useful mechanism for a grandparent to invest money on behalf of their grandchildren, typically to assist with things like educational costs, travel plans, getting married or buying a house.
The following guide is about bare trusts for grandchildren, namely where grandparents are looking to set up a trust fund to transfer assets to their direct descendants.
What are bare trusts for grandchildren?
A bare trust is the most basic kind of trust available, arising where assets are transferred into trust by the settlor, ie; the grandparent, for the trustees to hold for the beneficiary absolutely until they turn 18, ie; the grandchild(ren).
Typically, in bare trusts for grandchildren, the grandparent, together with the child’s parents, will act as trustee.
Having turned 18, the grandchild(ren) will have an immediate and automatic entitlement to the trust fund. As such, the bare trust, or absolute trust as it is commonly known, creates a fixed and absolute interest in the trust fund.
A bare trust can be used to bequeath assets to a grandchild who is still a minor after the grandparent dies. This is known as a testamentary trust.
Bare trusts for grandchildren can also be set up as a living trust, during the grandparent’s own lifetime, for example, to help fund their grandchild’s education. Here the benefits derived from the trust can be distributed before the grandchild turns 18 for the child’s benefit.
What are the benefits of using bare trusts for grandchildren?
There are both practical and financial benefits to a bare trust, in particular it can restrict the access of the beneficiary to the trust funds whilst they are still a minor. Instead, the settlor will retain control over the investments in the trust via the trustees, of whom they will usually be one, until the beneficiary reaches their 18th birthday.
In addition, as soon as any money or investments are put into a bare trust they are taxed as if they belong to the grandchild, which usually means there is little or no tax to pay on any income or gains. The same rule, however, does not apply to gifts from parents. If the income from such a gift exceeds £100 per year, the parent will have to pay tax on all the trust’s income.
In the long term, bare trusts for grandchildren can also help with inheritance tax planning, as assets paid into the trust will be treated as a potentially exempt transfer. As such, assuming the grandparent survives for more than seven years after the assets have been transferred into the trust, and before they are paid out, the gift will not be brought into account when valuing their estate for inheritance tax purposes.
Even where the grandparent dies within seven years, inheritance tax may only be payable at a tapered rate of between 8%-32%, rather than the usual 40%.
What are the drawbacks of bare trusts for grandchildren?
One of the main drawbacks to bare trusts for grandchildren is the lack of flexibility. The beneficiaries must be named and their shares specified at outset, and neither the beneficiaries, nor the share in which they benefit, can be altered once the trust has been established.
Another drawback to the bare trust is that the beneficiary can gain access to the trust fund at the age of 18. For this reason, the bare trust is rarely suitable for large sums of money, whereby the trustees no longer have any control over the trust fund, leaving the grandchild free to dispose of the assets and spend the money as they see fit.
That said, where a bare trust has been set up by a grandparent to help fund school or university fees, costs can be estimated from the outset leaving only a minimal balance by the time the grandchild turns 18.
What alternatives are available to bare trusts for grandchildren?
Trusts for direct descendants can take many different forms, but other than bare trusts for grandchildren, they normally fall within one of two types: the discretionary trust and the interest in possession trust.
The discretionary trust
The discretionary trust offers much more flexibility than bare trusts for grandchildren. Under this type of trust no beneficiary has a fixed or absolute entitlement to any share in it. Instead, the grandparent will specify a class of beneficiaries thereby giving the trustees the discretion to decide when and to what extent any grandchildren will benefit from the trust fund.
In this way, the discretionary trust can allow a grandparent to make financial provision not only for existing grandchildren, but also unborn grandchildren.
The discretionary trust also allows the trustees to retain assets beyond the beneficiaries attaining the age of majority, until they form the view that any given grandchild is old enough to manage the trust fund responsibly.
In this way, the grandparent, visa the trustees, will retain much more control over the money than under a bare trust, protecting the assets not only from financial irresponsibility, but also bankruptcy and divorce.
As with any type of trust, however, there are also drawbacks, not least the tax implications can be complex and very expensive where the trust fund exceeds the nil-rate band for inheritance tax of £325,000.
Further, under the discretionary trust the trustees will have, as the name suggests, a wide discretion over how to administer the trust fund. That said, a grandparent can provide what’s known as a ‘Letter of Wishes’ with specific guidance on how to manage and administer the trust fund.
The interest in possession trust
Under the interest in possession trust, a named beneficiary has an immediate entitlement to any income produced by the trust assets as and when that income arises.
This type of trust can be used where a grandparent wishes their grandchild to have the guaranteed use of income during their lifetime, but does not want them to have outright access to the capital. The beneficiaries entitled to the capital are also named in the trust.
Again, however, as with discretionary trusts, the tax position for interest in possession trusts can be complicated and costly.
Are there any potential pitfalls to setting up bare trusts for grandchildren?
Setting up bare trusts for grandchildren is relatively straight forward, and in some cases will not even require a trust deed. For example, where a grandparent wishes to set up an investment account to help fund their grandchild’s education, the account itself will act as a default bare trust from which school or university fees can be paid directly.
That said, it is always best to seek expert legal advice to ensure that a trust has been set up correctly, and that the bare trust in fact meets the grandparent’s wishes for their grandchild.
Why take legal advice about bare trusts for grandchildren?
By seeking expert legal advice about bare trusts for grandchildren, you can explore all of the different types of available trusts, selecting a trust to best suit the current and future needs of your loved ones.
Your legal adviser can even help you to create a mixed trust, combining different features from different types of trust, tailored to your specific set of circumstances.
The matters contained in this article are intended to be for general information purposes only. This article does not constitute legal advice, nor is it a complete or authoritative statement of the law and should not be treated as such.
Whilst every effort is made to ensure that the information is correct, no warranty, express or implied, is given as to its accuracy and no liability is accepted for any error or omission.
Before acting on any of the information contained herein, expert legal advice should be sought.