What is a trust for a child?
A trust for a child is a legally recognised structure where assets are held by a group of people (the trustees), for the benefit of another person or people (the beneficiaries). The person or people who put the money into the trust (the settlor(s) or truster(s) in Scotland), are usually trustees as well. This means that they can control how the money is invested, when and who to pay benefits to and make other important decisions about the trust.
Why do I need a trust for a child?
Until they become adults, a child cannot normally hold investments in their own name. There are some investments specifically designed for children, such as Junior ISAs, but these are generally limited in size, have narrower investment choices and access is often restricted.
Trusts can provide more flexibility, wider fund choices, easier access, greater protection of the assets from potential issues in their adult life (such as divorce or bankruptcy) and with care they can be a tax-efficient option too. Trusts are also unlimited in size, so for larger investments, trusts may be the only option.
Making a gift using a trust also allows you to make a sizeable gift during your lifetime and it will reduce your estate for inheritance tax purposes after seven years. You can also potentially control when the beneficiary receives any proceeds from the trust.
What are the benefits of a trust for a child?
There are several different types of trust, each with their own benefits and downsides. For larger investments for children, the most effective solution could be a combination of the different types.
What are the different types of trusts available for children?
Junior ISA (JISA) or Child Trust Fund (CTF)
Junior ISAs, and their predecessor Child Trust Funds, are a common choice. Although they are not technically trusts, Junior ISAs and Child Trust Funds are purpose-built investments for minor children.
Up to £9,000 can be invested into a Junior ISA each tax year. Any income or gains made are tax-free, both for the person making the investment and the child. At the age of 18, the child takes control of their investment and can roll the proceeds into an adult ISA.
Junior ISA contributions are limited to the annual allowance and there is no access to the money, even for the child’s benefit, until they reach age 18. Therefore, they can’t be used to fund school fees. They must be set up by the child’s parent or guardian, although other people can contribute.
Bare trusts for children
A bare trust is a more flexible alternative, particularly where contributions are being made by someone other than the child’s parents, for example, grandparents, uncles, aunts or godparents.
The income tax and capital gains tax on bare trusts is taxable against the beneficiary. However, if the beneficiary is the minor child of the person who contributed the money, and the income from the trust exceeds £100, the income is taxable against the parent.
This means that anyone other than a parent can invest on behalf of the child and utilise the child’s income tax and capital gains tax exemptions. The child’s allowances usually eliminate any tax liability, so even fairly large investments can grow tax-free.
Bare trusts are unlimited in size, they can hold almost any investment and money can be accessed for the child’s benefit prior to them reaching age 18.
The child can demand the money from the trust at age 18 (16 in Scotland) and do what they wish with it. They could use part or all of their annual ISA allowance (currently £20,000) to reinvest the money into a standard adult ISA so that the money can grow in a tax-efficient environment.
Nominee accounts for children
Although trusts are usually created using a written trust deed, it is in fact possible to create a trust without this document.
Nominee accounts are a form of trust similar to a bare trust. If a person invests in their own name with the intention of holding the money for someone else (perhaps their grandchildren) and they can prove their intent, then HMRC will usually accept that a trust was created. It is important that the investor does not use the money themselves or benefit from any income, and that it is always treated as being held for the other person.
Intention can be proved by writing a letter to the parents of the beneficiary, stating that you are holding the money for the child’s benefit.
For larger sums, a written trust deed is a valuable way of clearly demonstrating the intent to create a trust as there is no ambiguity for HMRC to question.
Discretionary trusts for children
Discretionary trusts are generally used for larger sums of money. They usually allow for a number of potential beneficiaries, often from across multiple generations of a family, and it is at the discretion of the trustees which beneficiaries receive money from the trust and when.
Money can typically be held in the trust for up to 125 years (it can be held indefinitely in Scotland), and because of the trustees’ discretion, the trust fund is generally protected if a potential beneficiary gets divorced, becomes bankrupt, is not mature or old enough to manage the money responsibly, or is uninterested or inexperienced when it comes to looking after their finances.
Money held in discretionary trusts do not form a part of the beneficiaries’ estates for inheritance tax purposes. Instead, the trust itself is potentially liable to a small tax charge every 10 years which is currently up to 6% of the value of the assets held within it. The trustees pay tax at the trustee rate on any income or gains. But if the income is paid to a beneficiary, the trustees can claim back any tax that they wouldn’t have paid themselves. The trustee rate of tax on income is 45% on interest received, 39.35% on dividends and 20% on capital gains.
Discretionary trusts are potentially more complicated to administer than bare trusts, and the tax on income and growth can be higher, although both issues can be mitigated with careful investment choices and planning.
Other trusts for children
There are many other types of trusts available. Some are specialist ones, used where beneficiaries are vulnerable or disabled, others are created almost accidentally by the terms stipulated in a Will. For example, if a Will states that a child only inherits at a specified age, it creates a trust with trustees in place to administer the money until the child reaches that age, even though the Will may not mention the word ‘trust’.
The powers of the trust and its tax position will depend on the wording of the trust (or the deceased’s Will). It’s important to seek professional advice when establishing a trust to minimise the tax liability attached, simplify the administration and make sure that the terms of the trust are not breached.
Can a trust be used for a child’s education?
One of the most common uses of trusts for children is to pay for their education. That could be to pay for private schooling or even to cover university costs, depending on the type of trust used.
A bare trust may be the most suitable trust to use if paying for private school fees, particularly if the someone other than the child’s parents are providing the funding. This can be very tax-efficient as the child’s income tax and capital gains tax allowances can be used. If, however, there is any money left in the trust when the child reaches age 18 (16 in Scotland), they can demand that the trustees pay this to them. If the child having control of the money when they reach adulthood is a concern, care should be taken not to put too much money into the trust.
Discretionary trusts might be a more suitable option if you wish to retain control of the money after the child is 18, for example, to pay for university fees.
Are trusts for children complicated and expensive to manage?
Trusts do not necessarily need to be difficult or expensive to run. Generally, they can be administered by trustees who do not have any experience of trusts or much knowledge of them but it is important to have professional advice at key moments, for example, when the money is invested or when there is a significant sum to pay to a beneficiary.
The complexity and cost of a trust will depend heavily on what the trust invests in. If it holds a portfolio of rental properties, then collecting the rent, maintaining the properties and accounting for the income, gains and expenses will all add complexity and cost. On the other hand, if you use an investment bond wrapper (if suitable) then there is no tax to account for until a chargeable event occurs, which means that the administration and reporting is vastly simplified.
How much control do I have over how the trust is used?
Most people who create trusts include themselves as trustees so that they have a say in how the trust is managed, although this is not obligatory. Under English law, all trustees must agree on any actions taken. Under Scottish law, a majority are able to act.
Trustees do not have free reign to do anything they wish. They are limited by the terms of the trust, as well as certain statutory obligations. Probably, the most important rule is that they cannot use the trust to benefit themselves. They must administer the trust to the best of their abilities for the benefit of the beneficiaries.
Some trusts require the trustees to pay an income to the beneficiaries or that capital is given to the beneficiaries at a certain age but others leave these decisions to the trustee’s discretion. It is therefore extremely important to understand your powers and obligations as a trustee.
How do I set up a trust for a child?
Trusts for children are normally created using a trust deed. It may be necessary to ask a solicitor to draft the deed, although if you are using an investment bond within the trust, the bond provider may have a suitable proforma trust available.
Whether you use a solicitor or a proforma trust, advice should be taken to ensure the trust is properly created and that all trustees understand the terms of the trust, along with their individual powers and responsibilities. It’s also important to seek professional advice on the most suitable investments to meet the terms of the trust and minimise the administration and tax costs.
What mistakes do people make when setting up a trust for a child?
Choosing the wrong type of trust for the circumstances
Bare trusts can be very tax efficient but how much money would you be happy for the child to have control of at age 18 (or 16 in Scotland)? Often a mixture of bare trusts and discretionary trusts is the best solution for larger investments so that control is maintained over when any significant money is received by the beneficiaries.
Trustees not understanding their obligations
Trustees need to understand each beneficiary’s rights under the trust and their own obligations as trustees. They need to ensure that the trust is properly registered and any tax liabilities are declared.
Taking advice at the time the trust is created and when any significant events occur will help you understand these obligations and avoid any potential issues.
Choosing unsuitable investments
Choosing suitable investments for the trust can help to minimise its tax liability, ongoing costs and administrative burdens and will enable trustees to meet their obligations under the trust, for example, providing income to those entitled to it and ensuring capital is available when it is needed. It is important to remember that the returns on any type of investment are not guaranteed and you could end up with less than the original contribution.
The trustees must act with ‘care and skill’ when administering the trust and that includes investing wisely on behalf of the beneficiaries. Trustees have a legal obligation to take professional advice on investments unless it is ‘inappropriate to do so’. Failing to exercise skill and care could leave them personally liable.
Talk to Evelyn Partners
If you want to know more about trusts for children or if you have any queries about an existing trust, our experts can help. Book an initial consultation online or call us on 020 7189 2400.
Advice in relation to trusts is not regulated by the Financial Conduct Authority, however, the products used in relation to trusts may be regulated.
This article is solely for information purposes and is not intended to be, and should not be construed as, personal advice.
This article was previously published on www.tilney.co.uk prior to the launch of Evelyn Partners.