Best way to give money to grandchildren?
|Investment | Life
Asked by dadbc1, submitted
03 March 2011.
My in-laws have inherited some funds - probably £150K - they are proposing to invest it for three children (aged 11,12 and 13) to pay their university fees and other costs - estimated at £15K pa each for 3 years the first one staring in 5 years time. So there would be a withdrawal of £15K in five years time, £30K the following year, £45K the year after, etc
They have been advised to use a St James's Place Investment Bond - not sure of the details of which funds - set-up as a trust.
I wondered what you view on this approach is as I have particular concerns around:
Is this the most tax efficient approach - as the investment fund has to pay 20% income tax on income and gains
The level of charges - reading the guide they will withdraw > 5% of the fund pa after year 5 so will incur partial withdraw charges not specified
Investment is short term so will tax and charges make it a poor investment
Unable to get a feel of the investment returns on the various funds - only can locate today's bid/offer prices
Look forward to hearing from you.
Answered by Justin on 05 March 2011
There are a few issues here to consider:
- Are your in-laws concerned about inheritance tax (IHT) when they pass away? Depending on their age, health and wealth this may or not be an issue.
- Assuming IHT is an issue then gifting the money will remove it from their taxable estate provided they live for a further 7 years. But it means waving goodbye to the money for their own use, so they need to feel comfortable they can afford to.
- Even if IHT isn't an issue, do they want to set something in stone to ensure the children will have a right to the money from age 18 and ensure equality? If so, then a trust can help achieve this.
- What sort of investment return would be required to provide the intended £15,000 per year per child from age 18 to 21?
- What types of investment could potentially deliver this return and how much risk would be involved? And are your in-laws comfortable taking this risk?
- What the most tax efficient and cost effective way to buy and hold these investments?
- Who's going to monitor/look after the investments over the next 10 years until the youngest child receives their last income payment?
I won't cover all the above in too much depth, else I'll end up writing another website and send you to sleep! But in broad terms:
If IHT is an issue and they can afford to give away the money then using some sort of trust will almost certainly make sense - I doubt they'll want the children to receive all the money in full now. For example, a discretionary trust will allow them to give the money away now but retain some control as to how it's invested, when the children receive money and how much they get. Your in-laws would be called the 'settlors' (the ones gifting the money) and might also act as 'trustees' (along, perhaps with others, e.g. you) whose job it is to ensure the money is invested and managed in line with the settlor's wishes.
If there's no IHT issue, then they need to decide whether to give the money away now anyway (via a trust as above) or keep it themselves with a view to passing money across to the children in future. The latter is simpler, but less robust in terms of the children definitely getting the money.
I'll cover tax in a moment, but let's look at what sort of investment return would be required to ensure £150,000 invested now can pay an income of £15,000 per year per child for three years between age 18 and 21. Ignoring charges and tax, an average annual return of 2.9% would just about suffice. Tax and charges could perhaps add a further 2-3% to the required return depending on which investments are used and how they're held.
In any case, this sort of return is certainly feasible without taking excessive risk. The simplest option would be to use a 5 year fixed rate savings account paying around 4.5%+ then do the same again on maturity (assuming interest rates are around the same, or higher, at that time) - minimal risk and no need to pay a financial adviser.
The downside with cash is that although safe, returns are unexciting and your in-laws might generate higher returns by investing. But this means risk - the children could end up with rather more or less than intended depending on how the investments perform. This is impossible to predict, so the best you can do when investing is use common sense and pick a spread of sensible investments to reduce risk.
If your in-laws hold the savings/investments themselves then they'll be liable to income tax on interest/dividends and capital gains tax on gains. Whether this is a problem depends on their tax band and whether they already use their capital gains tax allowance. They could use their joint ISA allowances to gradually remove the money from the taxman's claws.
If savings/investments are instead within a discretionary trust then dividends will be taxed at 42.5% and interest at 50% (on income above £1,000 a year). The income tax can be reclaimed in the hands of the children (assuming they're non-taxpayers) when eventually distributed (income tax paid by the trust before then can be rolled forward via a 'tax pool' meaning it could still be reclaimed by the children in future - see http://www.candidmoney.com/questions/question323.aspx my answer to this earlier question for more details and an example). So this route could be tax efficient (provided gifts are below the nil rate band, currently £325,000, else it'll be classed as a 'lifetime transfer' and extra tax will apply).
Discretionary trusts do get an annual capital gains tax allowance, but it's currently £5,050 - half the amount given to individuals. Gains in excess of this are taxed at 28%.
I'm not a great fan of investment bonds, but they can work quite well within discretionary trusts, especially when held offshore (no tax is automatically deducted within offshore investment bonds, it's 20% onshore). Up to 5% of the original investment can be distributed each year without being subject to income tax, and unused 5%s can be rolled forward to use in a later year. When the bond is eventually surrendered (probably when the youngest child has received their final payment) a big tax liability could arise in the trust, but this could be avoided by 'assigning' the bond to the children before surrender - if the children are non-taxpayers there may be little/no income tax to pay.
So, yes, using an investment bond could make sense in this context, but using an offshore variety would be most tax efficient. But beware that investment bonds tend to pay high sales commissions, probably £6,000+ on a £150,000 investment. I would favour a fee-based independent financial adviser in this instance, as St James Place advisers are tied to their own range of products. I wouldn't expect to pay fees of more than £2,000 for this work if pursuing the investment bond/trust route.