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Reasons for gifting

There are many reasons why parents or grandparents may want to make gifts for their children and grandchildren. It may be to meet the cost of school fees, pay off student debt or help them get a foothold on the property ladder. The prime motive may even be to reduce the value of their own estate for IHT.

The reason for gifting can have a huge bearing on how investments are held and the choice of investment wrapper. The age and tax position of the beneficiary during the investment period and the date funds are needed will all help determine the choice of investment wrapper. Investing to make use of the child’s tax allowances is key to maximising tax efficiency.

Gifting options

Outright gifts

Making an outright gift to a child or grandchild is the simplest way of gifting. It is effective where the money is needed for an immediate rather than a future purpose.

However, the age of the child will need to be considered. Are they old enough to hold the money or investments in their own name? And do they have the financial maturity to use it for the purpose it was intended?

If the answer to these questions is ‘no’, then it may be that the gift is not made until such time as the beneficiary needs the money for a particular purpose, such as university costs. But grandparents or parents may wish to save for these events in advance, holding investments in their own name while earmarking them for their children or grandchildren. This approach also keeps planning flexible should grandparents/parents change their mind for any reason, or in case they need emergency funds for another purpose.

Of course this will not be effective if IHT planning is a priority, and the tax status of the grandparent or parent will also influence the choice of investment wrapper as they will be taxable on income and gains.   

Where grandparents or parents do want to make a gift to minor children in advance of when the money is needed, bank accounts may be set up to hold cash gifts for a child with their parents acting as a nominee/signatory. But generally children cannot hold savings such as OEICs/unit trusts or investment bonds.

Trusts

Making gifts to a trust can allow the trustees to appoint money to the beneficiaries at the appropriate time and it prevents the child from being able to dip into their savings. It also allows gifts to be made for minor children and provides additional control. This may alleviate concerns about giving young children or grandchildren too much too soon.

Bare trusts are the simplest form of trust. The named beneficiary(ies) cannot be changed and future children or grandchildren can’t be added once the trust is set up.

The beneficiary has a right to both the capital in the trust and any income generated from it. They will be taxable upon any income and gains unless the parental settlements rules apply.

The trustees don’t have to pay out once the beneficiary turns 18*. The trust can continue. However, the trustees will need to notify the beneficiary and pass on details of income and gains generated so that the beneficiary can declare them on their tax return.

If a beneficiary demands the trust property once they are 18*, the trustees must pay it to them.

* 16 in Scotland

Discretionary trusts allow the greatest flexibility. The trustees have complete discretion over the payment of both capital and income. This allows the trustees to pay out at the appropriate time if funds are needed for a particular purpose. Alternatively, they can wait until they feel that the beneficiaries are old enough to look after the money themselves.

The beneficiaries are often described by class such as the children or grandchildren of the settlor. This means that if future children or grandchildren are born after the trust was created they are still able to benefit.

All this flexibility comes at a price. From an IHT perspective, gifts into a discretionary trust will be chargeable lifetime transfers (CLTs), and if they are greater than the available nil rate band they will incur a 20% tax charge. There may also be periodic and exit charges depending upon the value of the trust.

The trustees will have to pay tax at 45% on any income (39.35% for dividends) they receive. Capital gains are assessed on the trust at 20% (24% on residential property) (20% and 28% for 2023/24)  with up to half the personal annual CGT exemption available.

Flexible trusts share many similarities with discretionary trusts. They often have a wide class of beneficiaries who the trustees can appoint capital to and can include future children or grandchildren.

Flexible trusts also share the same IHT & CGT treatment as discretionary trusts.

The key difference is that there will be a named beneficiary or beneficiaries who are entitled to any income from the trust. Income cannot be accumulated and must be paid to the beneficiary.

The trustees generally pay tax at basic rate on income received but have the option to mandate the income directly to the beneficiary who is then responsible for declaring the income on their tax return.

However, where a flexible trust is created by a parent for their minor child the parental settlement rules will apply.

Wills and intestacy

Parents and grandparents will often leave money to children in their will. The terms of the will may create an express trust. That is a trust wording outlining how the money is to be held i.e. the type of trust.

But sometimes it may simply name the child or grandchild as a beneficiary. If the child is a minor this would create a bare trust if their interest cannot be taken away in any circumstances. If there any conditions such as, ‘for my grandchild X should they attain the age of 21’, this would create a contingent trust rather than a bare trust.

Professional advice should be sought to determine the type of trust as this will help determine the taxation and investment choice.

If a parent dies without leaving a will, their minor child may become entitled to a share of their parent’s estate under the laws of intestacy. There are different intestacy rules which apply for England & Wales, Scotland and Northern Ireland.

This will create a statutory trust for the minor child.

• In England and Wales the child’s entitlement is contingent upon attaining age 18. This is a Bereaved Minor Trust
• Under Scottish & Northern Irish intestacy rules children take an absolute interest upon their parent’s death and this creates a bare trust

Designated accounts

Some unit trusts and OEICs offer designated accounts. This allows an investment to be set up in the name of a parent or grandparent but earmarked for a particular child or grandchild.

However, there is no gift unless the designation is irrevocable and as a result creates a bare trust. The result is that the assets remain in the parent's/grandparent's estate and they will also continue to be taxable on any income and capital gains. There will be a potentially exempt transfer if and when the assets pass to the children/grandchildren.

Tax on the donor

IHT

Where a parent or grandparent makes a gift this will typically be either a PET or CLT. This will be outside their estate should they survive for seven years from the date of the gift.

However, certain ‘gifts’ may be immediately exempt, or just not regarded as transfers at all.

• Payments by a parent towards their child’s maintenance or education are not regarded as transfers of value and are therefore free from IHT. The child must be under 18 or in full-time education to qualify. This treatment does not apply to similar payments  from grandparents. These would normally be treated as gifts, and therefore either PETs if made directly or to a bare trust, or CLTs if made via a discretionary trust.
• Normal expenditure out of income. Regular gifts which are made from surplus income and do not affect the donor’s usual standard of living are immediately exempt.
• Annual exemption. Up to £3,000 can be gifted each year IHT free. If the previous year's allowance has not been used this can be carried forwarded to make £6,000.
• Small gifts. Any number of small gifts of up to £250 can be gifted each year.
• Gifts in consideration of marriage. Each parent may gift up to £5,000 in consideration of marriage or civil partnership. For grandparents the figure is £2,500.

Parental settlements

If parents make gifts for their minor child they may continue to be assessable for any income which arises from the gift. If income exceeds £100 each year then the whole amount will be taxed as the parent's. This limit is per parent, per child.

The rules apply where the child is absolutely entitled to income (for example if money was simply paid by the parent into a children's deposit account or the child´s entitlement is under an absolute or an interest in possession trust set up by the parent).

However, if the parent creates a discretionary trust where the child has no right to income then the parental settlement rule will only apply if income is actually paid to or for the benefit of the child.

The rules do not apply where grandparents make a gift for a minor grandchild.

Unit trusts and OEICs

It is not possible for a minor child to hold shares in an  OEIC or units in a unit trust so they are often held upon trust for the child or grandchild.

Bare trust

If held upon bare trust it allows the child’s own income tax (personal allowance, savings rate band, personal savings allowance and dividend allowance) and CGT allowances to be used.

It's therefore possible to take income and gains tax free provided allowances are not exceeded. While it is more difficult to control the level of income received other than by investing in lower income yielding/higher capital growth investments, more control may be exercised when it comes to taking gains. This can be achieved by rebasing shares each year  creating gains up to the CGT allowance. When rebasing, it should be remembered that sale proceeds should not be re-invested back into the same shares within 30 days as this would effectively cancel the transaction resulting in no gains and so potentially wasting the CGT allowance.  

The parental settlement rules will apply if a bare trust created by a parent holds unit trusts or OEICs for a minor child. All the income would be assessed upon the parent but capital gains will still be assessable upon the child.

There is no disposal for CGT when the trustees of a bare trust appoint unit trusts or OEICs to the beneficiary. The beneficiary is treated as if they have owned the property all along and will acquire the original base costs of the investment.

Discretionary trust

There will be a disposal for CGT If existing unit trusts or OEICs are transferred into a discretionary trust. However, holdover relief may be claimed to defer the capital gain.

Holdover relief is not available if the trust is set up by a parent for their minor children. This would create a settlor interested trust as capital can potentially be paid to a minor child.

Income from a unit trust or OEIC held in a discretionary trust will be taxable upon the trustees. The parental settlement rules will only apply if income is applied for a minor child.

Unit trusts and OEICs will pay income either as a dividend or interest depending upon the asset mix of the underlying fund. If the fund contains less than 60% cash and fixed interest, all income will be treated as a dividend. The trustees will pay tax at 45% on interest and 39.35% on dividend income. Frrom 6 April 2024 the £1,000 standard rate band has been abolished.  Instead trusts with income of less than £500 will have no tax reporting requirements and pay no income tax.  The £500 limit will be reduced if there are multiple trusts created by the same settlor.    Trusts with income over the £500 limit will pay tax on all income received) not just income in excess of the limit).

When income is paid to a beneficiary it loses its source nature; it is no longer dividend or interest and becomes trust income. Trust income is paid with a 45% tax credit and the trustees must have already paid the equivalent amount of tax in order to make the payment. This can be an issue if the trustees wish to distribute dividend income on which tax of 39.35% has been paid.

The trustees may pay CGT when they sell or switch funds. Gains in excess of the trust annual exemption £1,500  (£3,000 2023/24) will be taxed at 20%.  

Remember that the trust capital gains tax annual exemp amount is shared by any other trusts created by the same settlor. So for example, if a grandparent creates separate trusts for each of their 3 grandchildren then each trust would have £500 (£1,000 2023/24) to offset against gains.

When the trustees distribute funds to a beneficiary they have two options:

1. Encash shares/units in the fund and pay the cash to the beneficiary, or
2. Transfer shares or units into the beneficiaries name (if they are over 18).

Both will be a disposal for CGT. However, where shares/units are transferred to the beneficiary it is possible to jointly elect for holdover relief. This will defer any gain until the beneficiary makes a disposal. It also means the beneficiary can use their own full CGT allowance and any gains which fall which fall within basic rate will be taxed at 10% rather 20%.

Payments of capital either as cash or as a transfer of shares/units will be an exit for IHT.

Typically tax will only be payable if:

• there was tax to pay at the last periodic charge date, or
• if capital is paid out before the first 10 year anniversary, the initial value of the  trust was greater than the available nil rate band.

Flexible trusts

There are many similarities between flexible trusts and discretionary trusts. The IHT and CGT treatment of flexible trusts set up since 2006 is the same as discretionary trusts (see above).

The key difference between flexible and discretionary trusts is the treatment of the income generated by the unit trust or OEIC.

A flexible trust will have a named beneficiary(ies) who are entitled to all income as it arises. The trustees are not able to accumulate income. This means they must invest in income share/units rather than accumulation shares/units.

There are two ways which the trustees may deal with the income they receive from unit trusts and OEICs.

• The trustees can pay tax at basic rate (20% interest & 8.75% dividends) when income is received and pay it to the beneficiary with an R185 form to show the tax deducted by the trustees. Any tax deducted can be reclaimed if the child or grandchild is a non-taxpayer.
  
  The advantage of this option is that it allows the trustees to deduct any trust management expenses (from taxed income) before making the payment.
• Alternatively income can be mandated directly to the child or grandchild. All the tax is directly assessable upon the child.
  
  The advantage here is the simplicity and that there is no tax and reporting on the income for the trustees.

Investment bonds

Parents or grandparents can gift an existing investment bond to a child or grandchild but typically they will need to be over 18 to be the policy owner. The gift is achieved by a deed of assignment (usually provided by the bond provider). This is not a chargeable event and there will be no tax to pay. It will be a PET for IHT and will be outside the estate after seven years. 

Bonds are subject to the chargeable event rules.  Income and gains arising  inside the bond are not taxed on the bond owner. Instead, they will only be subject to an income tax charge if gains are made on full surrender of the bond (or surrender of individual bond segments), or when withdrawals are taken in excess of the cumulative 5% tax deferred allowance.

Using investment bonds for minor children will usually require setting up a trust.

Bare trust

Gifts, including the assignments of an existing bond, into a bare trust will be a PET.

Any chargeable gains are assessed on the beneficiary.

• Onshore bond gains carry a notional 20% tax credit which is non-reclaimable. This reflects the tax already paid by the fund. A child or grandchild will only have further tax to pay if the gain when added to other taxable income results in higher rate tax becoming payable. Top slicing is available to mitigate any liability to higher rate tax.
• Offshore bond funds do not pay any further tax on income and capital gains, benefiting from what is often referred to as ‘gross roll-up’. Gains made when money is withdrawn from a bond  falling within the child’s personal allowance, savings rate band and personal savings allowance will be tax free. This allows the potential for gains of up to £18,570 (2024/25) to be taken each year free of tax if the child has no other income.

The parental settlement rules will apply where a gain arises on a bond in a bare trust set up by a parent for their minor child. This will mean the chargeable gain will be assessed upon the parent but still with the top slicing available.

Once the child is over 18 a bond can be assigned to them. This will not change the tax position of any chargeable gains but it does allow them to manage the bond themselves.

Discretionary trusts and flexible trusts

The taxation of bonds in a flexible and discretionary trust is identical. Assigning bonds into the trust will be a CLT and if the value is greater than the available nil rate band there will be a 20% tax charge on the excess.

There are special rules to determine how chargeable gains are taxed when the bond is held in a trust (except for bare trusts which are taxed as above). The general rule is:

• Gains are assessed upon the person who set up the trust if they were UK resident and alive in the tax year of the gain. Any gains remain taxable upon the settlor until the end of the tax year in which they died
• Gains are assessed upon the trustees at 45% if the settlor is deceased or is not UK resident

Where the parent or grandparent is assessable as settlor they will benefit from top slicing. The parent or grandparent will also have a right to reclaim any tax they suffer  from the trustees.

There's no top slicing available where the gain is assessed on the trustees.

Once a beneficiary is over 18 the bond can be assigned to them. The beneficiary will then be assessable on gains as if they have always owned the policy. Top slicing will date back to the start of the policy and any previous withdrawals taken by the trustees will be included in the gain calculation.

It is generally not possible to assign a bond to a minor beneficiary. This means if money is needed gains may be taxable at the 45% trustee rate or at the parent’s or grandparent’s marginal rate.

However, it may be possible to complete a deed of appointment so that the bond (or part of it) is held on bare trust for the minor beneficiary. This will mean that gains will be assessed on the child. This will not work if the parent set up the trust as the parental settlement rules will apply.

Where bonds are assigned from a discretionary or flexible trust to a beneficiary or where a deed of appointment creates a bare trust this will be an exit for IHT.

Junior ISA

Parents and grandparents may make a contribution to a Junior ISA. The annual subscription limit is currently £9,000 (2024/25). This allows a pot of savings which are free from income tax and capital gains to be accumulated for the child or grandchild. As Junior ISAs do not pay tax on income the parental settlement rules do not apply.

If the annual subscription is paid each year from surplus income the gifts may be immediately outside the estate for IHT.

Third party pension contributions

Contributions can be made into a child or grandchild’s pension. Of course the downside is that the child cannot access the money until minimum pension age, currently 55.

If the child has no earnings then contributions will be limited to £2,880 a year but grossed up to £3,600 in the pension with the addition of basic rate tax relief. However, higher contributions can be made if the child has earned income. Contribution limits and tax relief are based upon the child’s tax position.

Paying contributions to an adult child’s pension can free up their income to be used on other things. This can be extremely helpful to young families to help with saving for a deposit for their first home, mortgage payments, child care or education etc. And as they are likely to have earnings themselves, higher amounts up to the annual allowance can be gifted.

The gift to a child’s pension, whether they are a minor or adult, will be a potentially exempt transfer for IHT.