The considerations involved in making a straightforward gift in your Will to minor children (i.e. who are under 18) are more complex than you might expect.
Prior to the 2006 Budget, a trust created for a minor (e.g. by a parent or grandparent dying leaving their estate between minor children who would become entitled at age 18 to 25 years) could qualify for favourable tax treatment. These were by and large Accumulation & Maintenance Trusts commonly known, as “A&M” settlements. However, since 22 March 2006 and the resulting Finance Act 2006, A&M settlements can no longer be created. Parents in particular with taxable estates must now weigh up the benefits of retaining assets in trust until their children reach an appropriate age and are mature enough to handle a large inheritance as against the disadvantage of a possible tax charge. Essentially, flexibility and peace of mind now come at a price!
The rules differ according to whether the Testator is a parent of the minor child or other relation. We have endeavoured to simplify the rules in both cases.
If your children inherit at age 18 there will be no Inheritance Tax charge on the funds in trust (beyond that payable on your estate in any event depending on the circumstances) when the money is eventually paid out to your child on their majority i.e. when they attain 18.
However, with effect from 22 March 2006 trusts which do not pay out the capital until the child reaches say 25 will be subject to the new “relevant property regime” from the moment the child reaches 18 until the capital monies are paid out at age 25.
These trusts will be known as Age 18-25 Trusts and will incur a charge to Inheritance Tax at current rates of 4.2% when the capital is ultimately paid out at age 25. This is effectively a proportionate charge; therefore, if the child is paid out at age 21, the tax charge will be reduced accordingly.
If an age greater than 25 is selected, the relevant property trust regime described below will apply from the date of death rather than just when the child reaches 18.
It is important to remember that the Inheritance Tax charge only applies to the extent that the assets held in the trust exceed the Inheritance Tax “Nil Rate Band” at the point that the money pays out. The Nil Rate Band, which is currently £325,000, has historically increased annually generally in line with inflation but is now effectively frozen as a result of the introduction of the new residence nil rate band.
If, in the light of the above, you decide that your children should inherit at 18, that gift can either take effect (vest) immediately on your death, or be contingent (conditional) upon your child attaining the age of 18. The pros and cons of these are discussed below:
Where an interest is “vested”, it belongs to your child outright. However, because minors cannot themselves own assets until they reach the age of 18, it will be held by your trustees, who are purely “bare trustees” holding the assets in name only until the child is no longer a minor. Income and capital gains tax on the bare trust assets will be based on the child’s tax circumstances because the assets are treated as being theirs.
The downside of a vested gift is that if your child dies before attaining 18 then since the assets are treated as theirs those assets will become part of their estate on death. A minor cannot make a Will and therefore cannot direct by Will where their assets should go. The intestacy provisions will determine the devolution of their estate, which may not be what you would want as more remote family members could benefit. Further, there may be Inheritance Tax to pay if the child’s estate is over the Nil Rate Band at the date of their death.
If the gift is contingent upon your child attaining a specified age and the child dies before they attain that age, since the assets are not theirs they are not part of your child’s estate but will instead pass in accordance with the further provisions of your Will.
A final point to bear in mind is that whilst a child’s access to capital can be restricted by the terms of your Will, your trustees have overriding statutory powers to pay out capital (and any income earned by that capital) if, in their discretion, it is deemed to be for the child’s benefit. Any well drawn Will by a solicitor will also extend the trustees’ powers in this regard. Thus your trustees can pay money to your child’s guardian or to the child himself on attaining 18.
Those making a Will (a Testator) therefore have the option of setting a vesting age of say 25 years for a child but giving the trustees full power to release earlier. Those trustees can then decide when the child reaches 18 whether the risk of distributing the assets in the trust fund is outweighed by the (probably quite modest) tax saving.
As you can see, this highlights the onerous and responsible nature of a trustees’ position – your choice of trustees is therefore crucial.
Following the changes in the Finance Act 2006 highlighted above, if you were now to write into your Will a gift to a minor which was contingent upon the child reaching a particular age, the funds would be held on a new form of trust known as a “relevant property trust”.
These trusts incur a periodic charge to Inheritance Tax on every 10th anniversary of the trust’s existence. There is also an “exit charge” when the money is paid out. The charge as the law currently stands is effectively 6%. It is possible – if not very likely in the opinion of a lot of commentators – this will increase with future budgets.
Of course, these charges do not apply to the first £325,000 of the fund (tax year 2016/17) – the so called “Nil Rate Band”.
In addition to Inheritance Tax, any income on the funds held in the trust, will be taxed at the Rate Applicable to Trusts, which is currently 45% (subject to a standard rate band applicable to the first £1,000 of income). Trustees pay capital gains tax currently at the rate of 28%.
An often overlooked consequence of the new inheritance tax residence nil rate band is that it limits the relief to narrow particular types of trust. This means assets left in trust to minor grandchildren such as most grandparents would like “to such of my grandchildren as reach 21” will not qualify for the relief!
Please note that these are general comments for guidance only and should not be relied upon without taking advice for specific situations. It should also be noted that they relate to trusts created by Will – trusts created by lifetime gifts are in general treated still less favourably for Inheritance Tax purposes.
If you would like to talk to a specialist solicitor about Gifts to Minors, please feel free to get in touch and explain your requirements with a no-obligation enquiry.
If you would prefer, you can also call our team on 01684 299633.
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