TT268: Grandparents – can you help educate your grandchildren tax free?
It is well known that the income of any child (above £100 per annum) derived from capital given by their parents is taxed as income of the parent themselves. It is this rule that prevents parents being able to pass capital to their children to enable them to generate income to use up their personal allowance or lower rate income tax bands.
However, the same rule does not apply to grandparents such that income generated from capital or assets given by a grandparent is taxed in the hands of their grandchildren. This allows grandchildren to use their personal allowance (currently £11,850) to reduce any income received by them which derives from amounts provided by a grandparent.
The use of a child’s personal allowance to cover off such income is a real tax saving opportunity which should not be overlooked by grandparents.
It may not be wise to give a sum of capital to a child’s bank account which is capable of generating a meaningful amount of income to make the exercise worthwhile. Such a sum of money would belong to the child absolutely and would create all sorts of issues as the child grows up, reaches majority and eventually marries.
In the UK, trusts are commonly used to solve the above issue. Trust law allows individuals to give capital into a trust and also to become a trustee so they can oversee the funds and how they are used. It is the trustees who ultimately decide when the trust’s income and capital is paid out and to who! As well as grandchildren the beneficiaries might include the children (now over 18 and with children of their own) of the grandparents.
1. At its simplest level, a grandparent can gift a sum of cash absolutely (a maximum of £325,000 per grandparent assuming no other chargeable lifetime gifts have been made in the previous seven years) into trust of which he then becomes a trustee.
The trustees can then appoint income generated on this capital out of the trust on an annual basis to grandchildren. The grandchild would then be able to use his own personal allowance to exempt him from the tax which would otherwise have been paid by the grandparent.
This income, usually passed into a child’s and guardian bank account, can then be stored up and used to pay school fees, training costs, school holidays etc. However, such funds absolutely belong to the child and any misuse of these by the guardian would breach the strict fiduciary rules applying in such cases.
At some future point in time, the grandparent trustee may decide it is time to appoint the capital out of the trust. At this time they would be free to leave the capital to their own child and not the grandchildren.
Of course, if the gift into trust occurred at least 7 years before the death of the grandparent, the trust capital will also be inheritance tax free.
2. It is possible to gift other income bearing assets into trust. In family companies, shares are often held across generations meaning that a grandparent may still own shares in the family company.
It is possible for a grandparent to pass a number of his shares into the trust such that any dividends paid on those shares are received as income by the trust. As above, such trust income can then be appointed out of the trust to the grandchildren. Again for tax purposes, this income would be reduced by their personal allowance.
It should be noted that a straight forward annual tax reclaim will need to be made by each child so they can reclaim the taxes arising in the trust as the income is generated.
As before, at a future point in time, the grandparent may decide to pass the shares out of his trust to his own children meaning the shares eventually end up where they would normally do.
Unlike cash, a gift of shares into trust is potentially subject to capital gains and inheritance tax. However, assuming certain conditions are met, there are exemptions to allow shares to pass into and out of trust tax free meaning that such grandchildren planning is often readily attainable.
Like with all tax planning, it is essential proper advice is taken as the pitfalls of such planning are numerous and the claims to relief from tax on the various transactions along the way are very complex.
Of course, your Barnes Roffe partner is there to provide you with all the advice you need to benefit from such tax planning.Talk to Barnes Roffe today