Estate Planning: Gifts and Trusts for Grandchildren

As we move through life, we naturally start to think about succession and how we are going to provide for future generations.

Our children may have flown the nest and started families of their own, and our minds begin to focus on the legacy we will leave behind.

Typically, our first thoughts are with our children and how we might help them, but increasingly individuals are looking to provide for younger members of their families – their grandchildren and possibly beyond, perhaps even skipping a generation in the process. This article explores the reasons why an individual may consider providing for their grandchildren and the ways in which they may do so through outright gifting and the use of trusts.

Why might an individual wish to benefit their grandchildren?

There are a multitude of reasons why someone may wish to provide for their grandchildren directly, instead of their children, and this will very much depend on their own unique family and financial circumstances.

One significant reason why an individual may wish to benefit their grandchildren, instead of their children, is that their children may already have their own wealth. Should further assets/funds be given to them by way of inheritance, either during their parents’ lifetimes or on their deaths, this will only increase the size of their own estates and negatively affect their Inheritance Tax position. Skipping a generation and passing inheritance on to grandchildren instead can, therefore, be a helpful way of assisting your children with their own estate planning.

An individual may also have concerns about their children which make them reluctant to pass assets to them; they may struggle managing their own finances or have a partner that they disapprove of, for example. Or, an individual may simply want to help their grandchildren with education costs or give them a helping hand on to the property ladder.

How might an individual benefit their grandchildren?

How a person provides for their grandchildren will depend on whether they wish to make provision for them during their lifetime or on death.

• Lifetime gifting

 Lifetime gifting can potentially be an invaluable way of minimising your exposure to Inheritance Tax.

There are a number of exemptions that that can be utilised during a person’s lifetime, which can mean that certain gifts can be made free of Inheritance Tax. This in turn has the effect of reducing the value of an individual’s estate and their potential Inheritance Tax liability on death (so ultimately enabling them to pass on more to their family).

For gifts that do not qualify for these exemptions, then provided an individual survives seven years after making an outright gift the value of that gift will no longer be considered part of their estate for Inheritance Tax purposes. This means that their estate is reduced in value and for taxable estates, so is the Inheritance Tax liability.  

If a gift is made and it exceeds an individual’s available Nil Rate Band allowance - this is currently a maximum of £325,000 but is reduced by the total value of chargeable gifts or transfers into trust made in the preceding seven years – and they die within seven years of making the gift, Inheritance Tax will be payable on that gift on their death. The amount of tax due may be less than the death rate of 40%, depending on when in the seven years the individual has died. There can, therefore, still be some advantages to lifetime gifting even if an individual does not survive the whole seven-year period.  Often the risk is something that may be insured against.

When contemplating lifetime gifting, it is very important for an individual to consider their current and future needs and resources. Once a gift has been made, it cannot simply be undone if you have second thoughts, or your circumstances change. An individual should also consider any previous gifts that they may have made in the seven years prior, and the Inheritance Tax and Capital Gains Tax consequences of making such a gift.

One such Inheritance Tax consequence is whether or not there is an immediate Inheritance Tax charge (i.e., a charge to Inheritance Tax as soon as the gift is made). There is no immediate Inheritance Tax charge for outright gifts to individuals. Gifts into certain types of trusts, however, may potentially have an immediate Inheritance Tax charge of 20%, if the gift is excess of an individual’s available Nil Rate Band allowance and any other available reliefs. If an individual dies within seven years of making such a gift into trust, further Inheritance Tax will be payable.

• Gifting on death

An individual may choose to include a gift in their Will for their grandchildren. This could be a simple legacy of an asset or money, or, alternatively, an individual may choose to include their grandchildren as beneficiaries of a trust in their Will, with an accompanying non-binding, but morally persuasive, Letter of Wishes detailing how and when they would like their grandchildren to benefit from the trust.

From an Inheritance Tax perspective, both children and grandchildren are non-exempt beneficiaries, which means that gifts made to them on death are not free of Inheritance Tax. There are therefore no particular disadvantages, from the testator’s Inheritance Tax point of view, of choosing to benefit one over the other.

With that being said, testators may be concerned that their estate will fail to qualify for the Residence Nil Rate Band – an additional Inheritance Tax allowance, which is currently a maximum of £175,000 – should they decide to leave their main residence (or the sale proceeds) to their grandchildren, instead of their children. Grandchildren do, however, fall within the definition of “direct descendants” and, provided all the other criteria for the allowance is satisfied, an estate should still qualify for the Residence Nil Rate Band if the deceased’s main residence (or the sale proceeds) is left to their grandchildren.

Should the gift be an outright gift or a gift into trust?

Once an individual has decided that they would like to make a gift to their grandchildren, either during their lifetime or in their Will, they should carefully consider whether they wish for the gift to be an outright gift or a gift into trust.

Legally, children cannot hold property whilst they are under the age of 18. Any outright gifts made to them whilst they are under this age will therefore belong to them beneficially, but the legal title to (and therefore control of) such assets will be held in the names of one or more chosen adults (usually their parents) as ‘bare trustees’, and will pass into their own names and into their direct control once they attain the age of 18.

There are many considerations which may influence an individual’s decision as to whether the gift should be an outright gift or a gift into trust and the reasons will again very much depend on an individual’s own unique family and financial circumstances. The age and personal circumstances of the recipient, the nature or value of the gift, whether they are happy for the recipient to be free to do with the gift as they please or whether they wish to restrict that, the set-up and ongoing costs of running a trust and the associated tax charges (and benefits), for example, are all factors that should be considered and on which advice should be sought.

Income tax efficiency will also be important. One reason why an individual may wish to benefit their grandchildren via a trust, is the significant income tax advantage in grandparents setting up a trust for grandchildren, compared with parents setting up a trust for those same beneficiaries. In a grandparental trust, the distributed income is taxed on the beneficiaries (with each grandchild having their own income tax allowance). In a parental trust, however, the distributed income is taxed on the parents until the beneficiaries reach 18 years old due to the anti-avoidance rules. This is something that appeals to a lot of clients, and often swings the argument in favour of setting up a trust for their grandchildren’s education, rather than making gifts to their children so that they can pay school fees themselves.  

Conclusion

Gifting to grandchildren is a very important, and somewhat under-utilised, aspect of estate planning. Whilst gifting, either during lifetime or on death, should be carefully considered, there can be major benefits, not least from an Inheritance Tax perspective, to assets skipping a generation and being passed down to younger members of the family, through outright gifting and the use of trusts.

Wrigleys Solicitors can advise you in relation to estate planning issues.  For more information or if you have any questions regarding this article, please contact Zahra Al-Moozany or any other member of the private client team on 0113 244 6100. You can also keep up to date by following Wrigleys private client team on Twitter. The information in this article is necessarily of a general nature. The law stated is correct at the date (stated above) this article was first posted to our website. Specific advice should be sought for specific situations. If you have any queries or need any legal advice please feel free to contact Wrigleys Solicitors.