Children or grandchildren cannot directly inherit a gift until they reach the age of 18. This is because they are not thought of as having the required ‘capacity’ to accept the gift. Until then, the gift will be held in some sort of ‘trust’.
Trusts are really not all that complicated or mysterious! If you leave your child £5,000 ‘in trust’, there will one or more ‘Trustees’ that you choose (people to look after the money), a Trust bank account (an account held in the name of ‘The Trustees of YOUR CHILD‘) and a document saying how the gift should be managed until the child is old enough to receive it directly (in this case, your Will).
There are a number of types of trust that can be used to manage whatever ‘trust assets’ that you are gifting – cash, land and buildings, shares etc. Some types are only available to parents – others can be used by parents, grandparents or anyone else. Each has its own tax rules. Some types also give the Trustees wide powers to deal with the assets until the child or grandchild receives it themselves. For example, you might allow use of some of the gift to buy things that the young person needs, before they reach an age where they can take the assets themselves.
Even when the young person reaches 18, you might agree that they are still too young to inherit a substantial asset. You might therefore want the trust to continue longer, or you might want to give the Trustees that choice.
Choosing the right trust involves a range of factors such as:
- Who you are (parent, grandparent, someone else)
- The age you want the child to inherit
- What the gift is (family home, cash)
- Your overall Inheritance Tax situation
- Whether you want the gift to be used (capital, income) before the child reaches an appropriate age to inherit
- The tax rules for the types of trust (Income tax, Capital Gains and Inheritance Tax)
- How much discretion you want to give to the Trustees
Below I review some of the types of trust available, who can use them and the taxation rules for each. There is a summary that you can download at the bottom of the page. Don’t worry if you find the different trusts a little confusing. I would be happy to discuss an appropriate choice for you when we meet, based on your circumstances and objectives.
Note that I am discussing these trusts in the context of your Will only, i.e. they are set up on your death.
Residence Nil Rate Band
I mention the Residence Nil Rate Band (RNRB) below for some types of trust. This is an additional allowance of up to £175,000 on top of your usual £325,000 Inheritance Tax allowance, where you leave a ‘qualifying residence’ to a ‘direct descendant’.
If you leave the qualifying residence (such as the family home) in trust rather than directly to your child or grandchild, sometimes your estate will still benefit from the RNRB, thereby saving Inheritance Tax. It depends on the type of trust you choose.
Types of Will trust for minors
Bare trust
Can be used by: parents, grandparents and others
Child gets gift at: 18
Overview
This is the simplest form of trust. The child owns the gift but it is simply held for them until they reach the age of 18. At this point, they can demand that the gift is transferred to them.
Residence Nil Rate Band
The additional Residence Nil Rate Band allowance is available for this type of trust (depending on what assets are gifted).
Income
If the assets generate any income before the child reaches 18, the child is entitled to that income. Income is taxed at the child’s own personal tax rate, and any personal allowances will apply. This is quite a big advantage because children typically don’t have any other form of income and their full allowance is therefore usually available. By contrast, other types of trust can attract much higher rates of taxation on income.
Capital gains tax
- If part or all of the assets are sold by the Trustees before the child reaches 18, Capital Gains tax is payable at the child’s own rate (there is an annual exemption).
- No Capital Gains tax is payable when the child reaches 18 and takes the assets, even if the assets have increased in value.
These rules apply because the child owns the assets for all intents and purposes even though they don’t have possession of it until they reach 18.
Ongoing Inheritance Tax charges
- When the assets are transferred to the child at 18, there is no additional Inheritance Tax charge (any Inheritance Tax due on the assets will have been paid at the time of your death).
- ‘Exit’ and ‘Ten Year Anniversary’ charges do not apply to this type of trust.
What if the child dies before they take the assets?
If they die before they reach the age of 18, remember that the assets always belonged to them so they will pass according to intestacy rules (since those under the age of 18 cannot yet make a Will). You can see what the intestacy rules are here.
The assets will fall into the value of their estate for Inheritance Tax purposes (the estate will have the usual Inheritance Tax allowances). No Capital Gains Tax will be payable (even if the assets have increased in value) and a tax-free uplift is available (that is, the assets are treated as being worth whatever they are worth at the time of the child’s death, rather than what they were bought for – this is a tax advantage for whoever inherits them).
Trusts for Bereaved Minors
Relevant law: IHTA 1984, s.71A.
Can be used by: parents only
Child gets gift at: 18
Overview
With this type of trust, the child can again demand the assets are transferred to them when they reach the age of 18. No additional Inheritance Tax is chargeable at this point. Capital Gains tax is calculated at this stage if the assets have increased in value, but ‘hold-over relief’ is available. This means that any tax due on the gain will not be paid until the child later sells or disposes of the assets.
Residence Nil Rate Band
The additional Residence Nil Rate Band allowance is available for this type of trust (depending on what assets are gifted).
Income
If the assets generate any income before the child reaches 18, what happens to that income is your decision. You will specify this in the terms of the trust. It can either be held in the trust or used for the benefit of the child. Either way, trust rates of income tax are payable* (which are high) – however, if the income is paid to the child, they may be able to reclaim tax.
*Unless the trust is classed as a ‘trust for a vulnerable person’.
Capital advances
With this type of trust, the Trustees may be given power to advance some or all of the capital for the benefit of the child before they reach 18. This means they can use some or all of the money to pay for large expenses, such as school fees or the purchase of a personal computer. The Trustees can also pay a small amount out per year ‘otherwise than for the benefit of the bereaved minor’ (currently £3,000 or 3% of the trust capital). This might be, for example, to fund a holiday for the child and other family members.
Capital gains tax
If the Trustees sell the assets or part of them before the child reaches 18, the trustee Capital Gains tax rate and annual exemption apply (unless the child is a vulnerable person and the trust qualifies as a special type of trust). Currently the Capital Gains annual exemption is half that of a ordinary person.
Ongoing Inheritance Tax charges
‘Exit’ and ‘Ten Year Anniversary’ charges do not apply to this type of trust.
What if the child dies before they take the assets?
If the child dies before they reach the age of 18, what happens to the assets is also your decision. Again, you will specify this in the terms of the trust. The assets will not fall into their estate for Inheritance Tax purposes.
18 to 25 Trusts
Relevant law: IHTA 1984, s.71B
Can be used by: parents only
Inherit at: 18 – 25
Overview
This type of trust will specify when the child can demand their gift, which must be some time after the age of 18 and before the age of 25.
Residence Nil Rate Band
The additional Residence Nil Rate Band allowance is available for this type of trust (depending on what assets are gifted).
Income
If the assets generate any income before the child is entitled to them absolutely, what happens to that income is your decision. You will specify this in the terms of the trust. It can either be held in the trust or used for the benefit of the child. Either way, trust rates of income tax are payable – however, if the income is paid to the child, they may be able to reclaim tax.
Capital advances
With this type of trust, the Trustees may be given power to advance some or all of the capital for the benefit of the child before they reach whatever age they become entitled to the assets.
This means they can use some or all of the money to pay for large expenses, such as school fees or the purchase of a personal computer. The Trustees can also pay a small amount out per year ‘otherwise than for the benefit of the bereaved minor’ (currently £3,000 or 3% of the trust capital). This might be, for example, to fund a holiday for the child and other family members.
Capital gains tax
If the Trustees sell the assets or part of them before the child reaches 18, the trustee Capital Gains tax rate and annual exemption apply (unless the child is a vulnerable person and the trust qualifies as a special type of trust). Currently the Capital Gains annual exemption is half that of a ordinary person.
Capital Gains tax is calculated when the child becomes entitled to the assets if it has increased in value, but ‘hold over relief’ is available. This means that any tax due on the gain will not be paid until the child later sells or disposes of an asset.
Ongoing Inheritance Tax charges
If some or all of the assets leave the trust once the child has reached 18, ‘exit charges’ will also apply.
Usually (in other cases) these would be 6% of the value for 10 years. Since there are only 7 years between 18 and 25, the rate is therefore 4.2% over the Nil Rate Band and this is only applied for the amount of time the property is left in the trust after the child reaches 18. In other words, these exit charges are very modest and many parents view them as a small price to pay to ensure the child inherits at a more sensible age.
What if the child dies before they take the assets?
You will decide what happens if they should die before reaching the age where they are due to inherit. The assets will not fall into their estate for Inheritance Tax purposes. However, if the child is 18 or over, the same exit charges apply if the assets are not then held on 18-25 trusts for other beneficiaries.
Immediate Post Death Interest Trust
Can be used by: parents, grandparents and others
Inherit at: Your choice of age OR no right to the capital
Overview
With this type of trust, the child has a right to any income from the trust immediately following your death. The child may or may not have a right to the capital (the assets) in the long term.
Residence Nil Rate Band
The additional Residence Nil Rate Band allowance is available for this type of trust (depending on what assets are gifted).
Income
If the assets generate any income before the child reaches 18, the child has a right to it. Income is taxed at the child’s own rate, and any personal allowances will apply.
Capital gains tax
If the Trustees sell the assets or part of them, the trustee Capital Gains tax rate and annual exemption apply.
If the child is entitled to inherit assets at a certain age and they have increased in value, Capital Gains Tax is payable and no holdover relief is available. This is a major disadvantage of this type of trust.
Ongoing Inheritance Tax charges
‘Exit’ and ‘Ten Year Anniversary’ charges do not apply to this type of trust.
What if the child dies before they take the assets?
What happens to the trust when the child dies depends on the terms of the trust. For example, the trust might pay the child the income from an asset for life, after which the asset passes to someone else.
It is a quirk that the value of the asset does fall into the child’s estate for Inheritance Tax purposes, even if the trust specifies that it will then pass elsewhere. However, no Capital Gains tax is chargeable and there is a ‘tax free uplift’ on the value (i.e. the asset is taken to be worth whatever it was worth at the time of the child’s death).
Discretionary trust
Can be used by: parents, grandparents and others
Inherit at: Discretion of trustees
Overview
This is the most flexible trust of them all. It allows your trustees complete freedom to decide when the child gets the assets (including any income they generate). In theory the Trustees may never pay out, or they could delay for many years, well into adulthood – although they must always act in the child’s best interest. This is a big advantage as it allows the Trustees to decide if and when the child is ready to receive the money (taking into account their maturity and personal/financial circumstances). However, there are quite a number of considerations with this type of trust.
Residence Nil Rate Band
The additional Residence Nil Rate Band allowance is NOT available for this type of trust. A variation of your Will might be possible within two years of your death in some circumstances, to allow claiming of the relief. However, consider that there are only limited circumstances where this might be desirable.
Income
If the assets generate any income, your Trustees have complete discretion as to whether to pay it to the child or not. Otherwise it will remain in the trust. Trustee income tax rates apply (these are high) but if the income is paid to the child, the child may be able to reclaim tax.
Capital gains tax
If the Trustees sell the assets or part of them, the trustee Capital Gains tax rate and annual exemption apply.
If the Trustees decide to pay out an asset to the child and it has increased in value, Capital Gains tax does apply, but ‘hold-over relief’ is available. This means that any tax due on the gain will not be paid until the child later sells or disposes of the assets.
Ongoing Inheritance Tax charges
‘Exit’ and ‘Ten Year Anniversary’ charges apply to this type of trust.
Each 10 year anniversary after your death, the trust is taxed on the value of the trust less the ‘nil rate band’ available to the trust (that is, the portion of your Inheritance Tax allowance that the trust can use). The rate of tax is 6%. If the value of the trust is less than the nil rate band, there will be no charge.
In addition, an exit charge is applied when capital is distributed to the child. This is basically a proportion of the 10-year charge, based on how long has passed between the last 10 year anniversary and the assets exiting the trust.
These ongoing tax charges sometimes make discretionary trusts look rather unattractive. How they will affect you individually depends on a number of factors such as the value of the assets to put in trust, and the overall value of your estate. Remember that the disadvantage of the taxes must be weighed up against the huge advantage of flexibility.
What if the child dies and there is still money in the trust?
It will pass according to the terms of the trust.
Trust for a vulnerable person
I have mentioned above that some trusts may be classed as ‘trusts for a vulnerable person’. These are for people or children with certain disabilities (or claimants of certain benefits) and they do attract special tax treatment if the trustees make a ‘vulnerable person election’.
So which trust?
You will see from this overview that there is definitely no one-size-fits-all! I simply cannot recommend one trust over the other, without knowing your circumstances. I will always help my clients make the best decision for their needs and objectives.
If you would like to download a summary of the above information, click here: Will Trusts for Minors (PDF).
The lovely image featured above is by Alfred Stadlmann – https://pixabay.com/users/steirerbua-3811
Jen is a practising Solicitor / Chartered Legal Executive and Commissioner for Oaths, admitted as a Fellow in 2006 and now SRA-regulated freelance. She started working in law in 2000 and her legal experience includes both private practice and in-house. She was Highly Commended by CILEX at the 2018 CILEX National Awards 2018 for Private Client expertise and she has authored work for the CILEX journal, LexisNexis and the Parliamentary Review amongst others.