How to safeguard children’s trust funds

Paul Thompson, tax & estate planning consultant at Canada Life Limited, explains how your clients can stop their grandchildren frittering away their trust funds.

When giving consideration to making a substantial gift to a young grandchild, it would not be difficult for a client to think that the little bundle of joy now bouncing on their knee will always be the apple of their eye.

As a result, it might be very tempting to follow the path of least resistance by creating a bare trust for the absolute benefit of the grandchild. After all, this would be a potentially exempt transfer (PET) for the purposes of inheritance tax (IHT) and that is better than a chargeable lifetime transfer (CLT), isn’t it?

Not only that, a bare trust has no periodic charges every ten years and no IHT exit charges when benefits are paid out. Whilst all that may be true to some extent, the big disadvantage is that, when the beneficiary reaches the age of majority, he or she can demand that the trust fund be paid out immediately. Is this really what the astute grandparent would want to happen? Would it not be preferable to construct a trust that allowed the trustees, or a parent, to hold the purse-strings and control access to the trust fund until the beneficiary had reached a more mature stage of life?

This can easily be achieved by creating a discretionary settlement. In many circumstances, this will be the obvious solution. Where the amount being gifted, after any available exemptions are taken into account, is within the client’s unused nil rate band, the impact of a CLT will be virtually the same as a PET. And if the size of the trust fund is relatively modest, it is likely that there will be no periodic or exit charges either.

But what if a sizeable sum is being considered or large CLTs have been made within the past seven years? In such circumstances, it may be desirable to make a PET instead of a CLT and to create a bare trust in order to avoid future periodic and exit charges. How can this be achieved without giving the beneficiary unrestricted access to such a large sum at the age of majority? Perhaps this case study will illustrate a possible solution to stop children frittering away their trust funds.

Case study

Edith, a widow, had approached her professional financial adviser with a view to some estate planning. This had been prompted by the arrival of her first grandchild, Edward, a couple of months ago. Edith wanted not only to provide for Edward’s future but also to reduce the value of her estate whilst retaining some access to benefits for herself in case of future need. She had already utilised her £3,000 annual exemption for both the current and the previous tax years.

After obtaining a full fact-find and considering her circumstances, Edith’s professional adviser recommended that she take out a £325,000 Flexible Reversionary Trust (see the previous article in this series). In addition, however, Edith wanted to make a £200,000 PET for Edward in the form of a bare trust, but she had concerns about giving him unfettered access at age 18. She knew that she could create a discretionary trust for £200,000, but that would mean it would be a CLT. Together with the £325,000 CLT for the Flexible Reversionary Trust, the total would exceed the nil rate band, triggering a 20% liability on £200,000.