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www.InvestmentGuide.co.uk How do you best give money to adult children while keeping control of it so the child or children can't blow the lot in a short time? How to avoid the impact of UK inheritance tax and maximise UK income tax reliefs and allowances. If you are a parent whose children are students or looking for a job or are taking a gap year, read on. We describes the use of trusts, power of attorney and what can legally be done to avoid all tax when accumulating money offshore.
This advice is not about Wills: you can arrange for money to be tied up in a Will trust after you die in a similar way to the advice given below. But by leaving it that late, you won't be able to avoid inheritance tax. These general rules may be useful to individuals in other tax juristrictions but obviously details of exemption limits, tax rates and allowances and time limits will differ - and trusts are not allowed in all countries.
Disclaimer: The information given here is detailed and covers a complex field of tax avoidance. While we are reasonably sure that the information and advice given is correct, the author and publishers regret that they cannot accept any liability for actions taken solely as a result of the information given here. Where large sums of money are involved it is imperative that you get a second opinion from a lawyer or accountant with experience of trusts and tax planning.
The problem
As you are reading this, you are probably one of a group of parents who feel that your financial obligations haven't ended once your child is officially no longer a child at the age of 18. Some parents don't feel that way. They have earned and saved their money - and take the view that their children can have anything left over after they die. Well fair enough. But if you feel you have to support an adult child, you have many choices about how to do it. Depending on individual circumstances there can be significant tax savings.
Income or capital
The first decision is whether you want to support your child by giving them their own personal social security. By doing so, you can be depriving them of State benefits if they are unemployed or sick or are eligible for housing benefit if they rent a flat or house from someone else. That has to be set against what can be a useful saving in taxation in other respects. However if you are reasonably wealthy, it is unlikely that State benefits will be very significant since the Government has now restricted the amount of housing benefits payable to people under age 25 who take out new tenancies.
You can no longer get tax relief by giving your child an income through a covenant. However an adult child has his own tax allowances and reliefs - and if he or she is a student or is not gainfully employed and does not already receive a taxable income or salary, then there are significant tax allowances to be exploited.
The personal tax allowance for the 2008-2009 tax year is £6,035 (click for current and previous years). That means that an adult child can receive income of up to that amount without paying any tax. If you are a 40% taxpayer, that is a saving of £2,414 a year for each child. Of course once the child gets a full time job, there is still a saving, albeit at a reduced rate as your adult child's investment income would only be taxed at 20% instead of 40% in your case. So the saving would still be £1,207 a year. It will probably be some time before the child itself becomes a higher rate taxpayer. That happens when an individual's income exceeds about £41,000 a year.
To generate an income of £6,035 a year, you need to invest capital of more than £100,000 in a bank or building society or fixed interest stocks. That's a lot of money to give to an 18 year old - and you would crazy to just give it with no strings attached. This sort of money buys a small Porsche or convertible Mercedes although having bought the car, they probably couldn't afford the insurance. If the money is invested in investment trust or index tracking unit trust or Exchange Traded Fund (iShares) the tax saving is less and only extends to the difference between the basic and higher rates of tax - so no tax saving here for basic rate taxpayers.
Giving but not giving
There are seven main ways of trying to keep control of money which you want to provide an income for your adult children of varying degrees of complexity. The first four are suitable for large amounts of money. The last three are more suited for smaller sums.
Lending money to a child
You can lend money to an adult child and keep control over the investments in which the money is invested. For instance if you lent your adult child £60,000 to buy an investment trust or index tracking unit trust or Exchange Traded Fund (iShares), the shares would be bought in the adult child's name - and the income and any capital gains would belong to the child.
However you would need to get the child to agree to you having a secured loan with a charge over the shares which means the shares can't be sold without your permission - or before the money you have lent has been repaid. With the new system of buying and selling stock exchange securites in nominee names or registered at Crest, taking a legal charge may be more problematical than in the past when it was just a question of getting a standard form signed and you keeping the stock or share certificates. A charge is a loan secured on an investment. A mortgage which you get to buy a house or flat is a secured loan where the charge is on the property.
A loan has to be repaid. It can also be liable for interest. Interest can be paid or accumulated to increase the amount of the loan. The repayment date can be specified as, say, 25 years time which would be appropriate for a mortgage; or it can last for shorter of the adult child's life or your life assuming that on your death you will leave the child enough to repay the loan. Any interest actually paid or credited to you in a tax year would be taxed as your income in that year. But if the interest is allowed to accumulate, then if it were actually paid (by deduction from the proceeds of the sale of the shares it is secured on, for instance) then it would all be taxable in the year the loan ended. However if you are never paid or credited with any interest - then there would be no income tax to pay on it.
The advantage of a secured loan charged on an asset is that your adult child really owes the money. He or she is only able to sell the asset with your permission because if the asset is sold, you can demand repayment of the loan. So that prevents the adult child from spending the money on anything you don't approve of.
It also has the advantage of protecting the child who incurs financial liabilities - say after a failed business venture or a divorce. Banks almost always require personal guarantees for loans and overdrafts and have no compunction in selling up someone's home in the event of a failure.
Or suppose your son or daughter's spouse leaves for no apparent reason and then demands a share of the proceeds of sale of the marital home. If he or she was awarded a third of the value in a divorce settlement, but the loan plus accumulated interest came to close to the value of the home, then your loan would have to be repaid first before your adult child's ex received anything.
The snag is inheritance tax. A loan is not a gift. So unless it is repaid - or you agree to let the adult child off part or all of it at least seven years before you die, then when you die, the loan plus any accumulated interest, counts as an asset in your estate and will be liable to inheritance tax assuming your estate is over £312,000 for the 2008-2009 tax year and planned to rise year by year to £325,000 in 2009-2010.
Giving your adult child a large loan is particularly suitable if you buy a house or flat for your adult child to live in. You also have better security as the mortgage will be registered at the Land Registry although there is no longer a physical Land Registry Mortgage Certificate for you to keep. If your adult child has a commercial mortgage as well, yours would be a second mortgage and you would need the permission of the bank or building society which has granted the first mortgage. Any interest arrears on the commercial mortgage would be paid before any of the capital you have lent.
Most gifts you make while you are UK domiciled are potentially liable to inheritance tax. Under current rules most gifts will still be fully taxable (currently at 40%) if you die within three years and possibly for seven years. What is more the exemption limit, currently £312,000 (for the 2008-2009 tax year) is first set against gifts in the past seven years. So unless you and your spouse give away more than £312,000 each, you don't actually save any inheritance tax until seven years have passed. However if you and your spouse give away more than £312,000 each, then you start saving tax 4 years after the most recent gift which puts your cumulative total of gifts in excess of the current limit at the time. Either way, once seven years have past, then there is no further liability to inheritance tax on an outright gift or a gift to a specific trust. It's possible that a new government might extend this limit to 10 years (which it used to be) or even introduce a gifts tax on large gifts over the exemption limit (it used to be at half the rate on death).
A trust is an arrangement where the legal ownership of assets is separate from the beneficial ownership. The legal owner is the person whose name the asset is held. The beneficial owner, the person who benefits from the trust, is usually someone else. The main feature of trusts is that they prevent beneficial owners doing what they want with the capital assets of a trust. Income is either accumulated or paid out to one or more beneficiaries. Different sorts of trusts have developed because of various tax laws which have been introduced which attempt to reduce their tax avoiding properties.
The rate of tax for Trusts is 40%, and 32½% for dividends, since 6 April 2004. Small trusts with an annual income of £1,000 a year or less since 6 April 2006 pay tax at a rate of 20% for savings income or 10% for dividends. The £1,000 a year applies to all Trusts together of one particular settlor.
The likely outcome of these changes is that Trusts which distribute their income each year to beneficiaries will be unaffected but those which accumulate income in taxable assets will pay more tax.
The most common trust is an accumulation and maintenance trust. This has become popular as a means for grandparents to channel money to grandchildren to make use of a child's personal tax allowance which is described fully in the chapter Children's Investments.
An accumulation and maintenance trust can also be suitable for your own adult child. Certainly you can use it if you have only one child to support. It would also be suitable where all your children are already adults (i.e. over age 18 ). However it could be inconvenient if one or more of your children are still under age 18 as their share of the trust income would be added to yours and you would be taxed on it so there would be no tax benefit. On the other hand if all the children are already adults, any unused personal tax allowances and bands for each child could result in significant rebates.
Since 22 March 2006, new accumulation and maintenance trusts and additions to existing trusts are treated in the same way as discretionary trusts (see below) unless the assets go to the beneficiary absolutely at the age of 18 (or the Trust was amended to achieve this before 6 April 2008) or the Trust is for a disabled person in which case the age 25 applies instead of 18 and the new rules don't apply.
These Trusts are therefore now only suitable where the amount to be transferred to the trust is below the donor's accumulated inheritance tax disposals and the value of the trust itself is, and is likely to remain, below the inheritance tax threshold.
There has been a change to the original proposals regarding accumulation and maintenance trusts set up by a Will: on death such Trusts will avoid the 20% inheritance tax charge and a child who inherits at the age of 25 will pay tax at a rate of 4.2% every 10 years on the value of the trust and pro rata at the age of 25. You may need legal advice on the consequences of this if your will provides for a Trust for children under 25.
Such a trust should be set up with a deed and you should get one drafted by a solictor or chartered accountant with experience of drafting this type of trust - that might cost you £500 or so. Usually capital was available to beneficiaries on their 25th birthday but that is not essential and under the new rules is likely to change. You can choose how long the trust can last which might be until you die - or until your adult child reaches the age of 30 or 40. Such trusts usually have the power to advance capital earlier at the trustee's discretion. It is possible that some of the tax avoidance benefits of accumulation and maintenance tax will be tackled by the government although this is less likely to affect trusts which have been set up before the legislation is enacted.
However once set up, each child (from age 18) is entitled to his or her share of the income of the trust. The only way to avoid paying income out every year would be to invest the trust money in assets which do not have a taxable income - for instance the accumulation versions of Offshore Single Foreign Currency Fund or Offshore Single Sterling Currency Fund or some form of Life Insurance which only have an income when they are disposed of. However in such cases, were such an investment disposed of, each beneficiary might be entitled to the full share of the profits liable to income tax in the year of disposal. Most assets which grow in value are liable to capital gains tax rather than income tax, so profits on disposals would not need to be distributed to beneficiaries.
Another way is to invest in investment trusts, unit trusts or offshore funds with a low or nil income yield which make their profits from capital gains. However when these funds are disposed of, they would then be liable to capital gains tax at the usual rates.
You can set up a discretionary trust for all your children where the trustees (which can be you and your wife or husband) decide how much income, if any, each child receives at any time. The Trust can be defined more widely if you like, for instance, all the descendants of your mother or father, or your spouse's mother and father, which would include your children, grandchildren, brothers and sisters, nephews and nieces and great nephews and nieces even if they are not yet born. At least one beneficiary must be alive for the Trust to be set up.
For instance the trust could pay an income to each child depending on their needs. Those in a full time job and doing well need be paid nothing and those struggling or without any taxable income or not eligible for State benefits can have the income divided between them.
As with all trusts set up by parents for their own children, they are not suitable for beneficiaries who are not yet age 18 (unless they have married and are over 16) as the income from the trust is deemed to be yours. Any income not spent can be accumulated and could later be used to support grandchildren - say for paying for school fees.
Discretionary trusts (and now new accumulation and maintenance trusts) have a few snags, however. There can be inheritance tax when money is given to the trust. It comes into effect once cumulative gifts within the previous seven years exceed the inheritance tax threshold (£312,000 for the 2008-2009 tax year). The tax rate is at half the rate paid on death (currently 20% instead of 40%). Discretionary trusts also have to pay inheritance tax once every 10 years on the capital value of their assets if they are worth more than the inheritance tax threshold at the time. Currently that tax is about 6% of the capital value of the Trust at the time.
If a discretionary trust is set up below the inheritance tax threshold, there is no inheritance tax when it is set up, provided cumulative gifts within the previous seven years including the amount given to the Trust are in total less than the current inheritance tax limit. There is nothing to stop a husband setting one up for £312,000 and his wife setting up a separate trust with identical provisions for a further £312,000. Both would remain below their respective thresholds and no inheritance tax would be payable. However if after 10 years, the value of assets grew above the then inheritance tax threshold, there could be some inheritance tax in the future on the then capital value in excess over the then threshold.
All the types of trusts described above can be set up in a tax haven. Most tax havens do not assess tax on trusts in their juristriction. The most convenient are Jersey, Guernsey and the Isle of Man. However if you, the settlor, are a UK resident at the time you set up a trust, there is no tax advantage as the Inland Revenue will aggregate any trust income with your own. Also if any trustees are UK resident, then the trust doesn't count as an offshore one and is liable to UK tax.
The disadvantage of offshore trusts is that you need independent trustees offshore. They will charge for their services and there is always the problem that the assets of the trust must be registered in their name, so they had better be a respectable and well known bank or trust company. If you set up an offshore trust while a UK resident and don't tell the UK Inland Revenue, then that is tax evasion which is a criminal offence. You should obtain professional advice if you wish to set up an offshore trust while you are non-resident. You must also consider the tax rules in the country in which you are resident at that time.
A trust with interest in possession
This usually comes about as a result of a Will. Someone is given an interest in possession or life interest. For instance a widow may be given the right to live in a house and/or have the right to income for the rest of her life. When she dies, the Will decides who will receive the remainder. The person who has the interest for life is called the life tenant. The person who gets the balance, is called the remainderman. A person with a life interest does not necessarilly have to die to end the life interest; for instance a widow may lose her life interest, partially or fully, if she remarries.
The rules have also been changed for some new interest in possession trusts since 22 March 2006 and they may also will liable to inheritance tax in the same way as discretionary trusts. However "straightforward interest in possession trusts created by a Will" are unaffected according to HM Revenue & Customs. You may need legal advice on this.
Buy a flat or house (especially suitable for under and postgraduate students)
You can use your money to buy a flat or house for the child to live in. They could receive rent from a lodger and not have to pay rent themselves. If they take a lodger, the first £4,250 a year of rent paid by the lodger is exempt from tax under the Rent A Room Scheme. If your child has no other income, he or she is also entitled to a personal allowance of £6,035 for the 2008-2009 tax year (click for previous years) so could receive £10,285 a year tax free in rent from people sharing.
So it looks like the ideal purchase is a three bed flat where each of the two spare rooms can be let out at up to £93 a week each.
Now suppose you bought the same property yourself as an investment. Suppose you could let it for £279 a week which comes to £14,508 a year. You would pay tax at 20% or 40% on your rents which come to £2,901 a year or £5,803 a year. Your child might be eligible for housing benefit but the rules now restrict this to a maximum of £50 a week for new single applicants under age 25. So to finance your money-less offspring, you would have to pay his or her rent at a rate of up to £93 a week or £4,836 a year.
So out of your £14,508 a year rent after paying tax and paying your child's rent elsewhere you have left at worst £3,370 to give to your child for living expenses compared with the £10,285 in the example above.
What is more, if the house or flat in the past has appreciated in value. If held in your own name it would be liable for capital gains tax when you sell, whereas if owned by your son or daughter outright or as beneficiary of a trust, the gain would be exempt as they would count as an owner-occupier. The house or flat could be owned by a trust with your adult child as the only beneficiary, be owned by one or more discretionary trusts where the occupant is one of the potential beneficiaries or you could provide the money through a loan. The only snag could be inheritance tax if the value of the house or flat is more than the inheritance tax threshold.
You can invest money in an adult child's name but keep the account registered at your own address and not give the documentation to the child. The child would have to initially sign to apply for each investment - and may or may not be happy to sign without knowing what is being applied for.
This could be suitable for a tax exempt investment like an ISA or National Savings Certificates either index-linked or fixed where there is no need to make a tax return of income or capital gains.
However care shoulld be taken to ensure the child does not get into trouble by attempting to invest themselves with their own money and inadvertently exceeding the maximum allowed. Any change in investments needs the child's signature.
You can hold money as a nominee for the adult child either yourself or jointly with the child. Where you are a nominee, this is called a bare trust. This will be unsuitable for an ISA as they are not allowed to be issued to nominees. However bank and builidng society accounts can be held single or jointly on behalf of someone else and so can National Savings Certificates. The main thing is to let the child know of any taxable income which needs to be returned to the Inland Revenue. Very few people now receive a routine tax return - and it may be that you can handle a tax rebate application on their behalf by getting yourself registered as their agent.
A power of attorney is a document which anyone over age 18 can sign which gives power to someone else - or more than one person - to sign documents on their behalf. The power can be limited to specific documents or left open. It is not to be given lightly because with a power, someone can go to your bank and withdraw all the money from your bank account.
A power of attorney is really intended to be used when the person who has granted the power is not available, for instance has gone trecking in the Himalayas. Although the attorney allows you to buy and sell assets on behalf of your son and daughter without them having to sign the documents themselves, the assets still belong to your adult child - and any taxable income or capital gains from them must be returned on the adult child's tax return.
A power of attorney is therefore unsuitable if you don't want the child to know about his or her wealth - or the full extent of it. Even if an investment was made using a power of attorney, it is perfectly legitimate for the adult child to turn up at the bank or building society to withdraw on his or her own signature without even notifying you.
Nowadays most people have used an enduring power of attorney which can continue to be used, subject to certain rules, even if the person who has granted the power become mentally disabled.
Since 1 October 2007, the name for new powers of attorney of this type has been changed to lasting power of attorney and a much more complicated procedure is involved in setting one up; for instance the document runs to 25 pages of form filling instead of four previously. Also a new lasting power of attorney needs to be registered with the the authorities when it is made, not as previously, when the person granting it has lost his or her mental capacity. However any enduring power of attorney made before 1 October 2007 continues to be valid and the old procedures will apply.
You can find out about how to set up a lasting power of attorney from the Office of the Public Guardian, previously known aas the Court of Protection. If there is more than one attorney, then the power can be jointly and severally in which case all or both have to sign each document or just jointly in which case either can sign.
The Inland Revenue does not usually accepts a power of attorney signature on a tax return unless the person on behalf of whom you are signing is physically or mentally incapable. This is the only circumstance where it cannot be used instead of the original signature.
 Last updated 14 May 2008 |
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