Estate Planning – Investing On Behalf Of Grandchildren

We often get asked by grandparents how they can invest on behalf of their grandchildren. The primary reason is to help the grandchildren financially for the future but it can also help with the grandparents’ own Inheritance Tax (IHT) position.

In this article, we are going to look at three simple ways grandparents can help their grandchildren financially. Naturally, not all of these financial solutions will be applicable and you should seek independent advice specific to your own situation.

Our Scenario

Our grandparents, Tom and Barbara, wish to help their two grandchildren, Archie and Amelia and they are discussing the situation with their children over Sunday lunch.

They explain that they have recently received an unexpected inheritance of £50,000 from an elderly friend.

Tom and Barbara are also in the fortunate position of being in receipt of Defined Benefit pensions; Tom from the Universities Superannuation Scheme (USS) after a career as a History Professor and Barbara from the Teacher’s Pension Scheme after a career as a secondary school English Teacher and they have identified that they have surplus income of around £24,000 per annum.

Archie and Amelia are three-year old twins and it is not clear whether they will go to a fee-paying school. If they do, their parents, who both have successful careers, will pay any school fees.

In our scenario, we have assumed that investment returns are 5% per annum net of any fees and charges. Of course, in real life, investment returns can and will fluctuate and will be more or less than this.

Offshore Bond to Fund University Fees

Tom and Barbara wish to invest £50,000 now to help their two grandchildren with university fees when the grandchildren are 18.

In this case, a possible solution is to invest the lump sum into an Offshore Bond held within a Bare Trust with the grandchildren as beneficiaries.

The gift to a Bare Trust represents a Potentially Exempt Transfer (PET) and, as such, will fall out of the grandparents estate after seven years.

An Offshore Bond can grow largely tax free (known as gross roll-up) and be invested in a wide-range of investment funds. The Bond itself is made up of lots of different segments which helps with flexibility.

At age 18, both Archie and Amelia have been accepted on to university courses. Over the 15 years that the Offshore Bond has been in existence, it has grown from £50,000 to almost £104,000. For the next three years, segments of the Offshore Bond are assigned to Archie and Amelia and then surrendered in order to meet their university expenses. As they are both non-tax payers without any income, there should be no tax to pay.

Junior ISAs to Help With Property Purchase

Tom and Barbara know how hard it is for young people to get on to the property ladder and want to give their grandchildren a head-start.

They explain to their children that they would like to contribute the maximum £9,000 into a Junior ISA each for Archie and Amelia. As grandparents, they can’t set up the Junior ISA and will need their children to do this. Once set up, however, Tom and Barbara can make contributions.

In our scenario, Tom and Barbara make contributions on behalf of the grandchildren for 15 years until Archie and Amelia are age 18.

Taking our assumed growth rate of 5%, the Junior ISAs have grown in value so that they are now worth just over £200,000 each. At age 18, the Junior ISA becomes a full ISA and Archie and Amelia now have overall control. Being sensible people, they keep their ISA invested until they decide to put it towards a property purchase.

Junior SIPP to help With Retirement

Tom and Barbara acknowledge how fortunate they are to be in receipt of Defined Benefit pensions and appreciate that there are likely to be fewer Defined Benefit Pension Schemes available when Archie and Amelia enter the world of work. As such, they want to ensure that their grandchildren have a head-start when it comes to their retirement.

Tom and Barbara decide they want to contribute the maximum they can to a pension for Archie and Amelia and this will be a Junior Self Invested Personal Pension (SIPP). They can contribute a maximum of £3,600 per year gross which will cost them £2,880 per year net and the tax relief is automatically applied to the pension.

Once again, Archie and Amelia’s parents will have to set up the Junior SIPP, but Tom and Barbara will make the contributions.

In our scenario, we are going to assume that Tom and Barbara make contributions for 15 years stopping when the grandchildren are age 18. Of course, Archie and Amelia cannot access their pensions until at least age 57 and more likely age 58, if not higher by the time they retire. Taking our assumed growth rate of 5% per annum, Archie and Amelia’s pension could be worth over £500,000 by the time they come to take benefits.

Complexities

We have used a relatively straight-forward scenario to demonstrate the types of financial products available for grandparents to invest on behalf of their grandchildren but, like most things, there can be added complexities to consider and this is why speaking with a Financial Planner is so important. Some of the complexities include:

Inheritance Tax

In our scenario, Tom and Barbara have surplus income which they can gift without materially affecting their lifestyle. If the contributions to the Junior ISA or the Junior SIPP were coming from capital and not income, these could be classed as Potentially Exempt Transfers (PETs) and be taken into account when calculating a potential IHT liability (after factoring in the £3,000 annual exemption).

In our scenario, Tom and Barbara invested £50,000 into an Offshore Bond placed in a Bare Trust which was a Potentially Exempt Transfer (PET) for Inheritance Tax purposes. A much larger amount into, say, a Discretionary Trust will be treated as a Chargeable Lifetime Transfer (CLT) and, if in excess of the nil rate band, could attract tax immediately at 20%. There could be other tax charges including periodic and exit charges.

Access and Control

I know that some clients may have concerns about when their grandchildren can access the money and for what purpose. In our scenario, we have used a Bare Trust for the lump sum which means the grandchildren are absolutely entitled to the money at age 18. We have also used a Junior ISA each and, again, the grandchildren will have full access and control of the money when they reach age 18.

Where grandparents want to specify when and how their grandchildren can access the money, a Discretionary Trust could be used instead, however, there may be additional tax charges that need to be taken into account.

Equal Treatment

To make the scenario as simple as possible, Archie and Amelia are twins. However, most grandparents will have grandchildren of different ages and so trying to arrange equal outcomes can be extremely difficult given varying timescales and investment returns.

Family Discussions

This, to me, is one of the most important aspects of inter-generational wealth planning. In our scenario Tom and Barbara discuss helping the grandchildren over a family Sunday lunch. Having a discussion with your children and talking about how you want to help is really important so that everyone knows your wishes and can plan accordingly.

Wills and Powers of Attorney

Having your Wills and Powers of Attorney in place is, again, very important. Your Will sets out who you would like to benefit from your estate and a Power of Attorney will enable a loved one to make financial, property and health decisions on your behalf if or when you lack the mental capacity to make your own decisions.

Seek Advice

Estate Planning is a complex area and it is important to take into account your wishes and what you are looking to achieve before searching for suitable financial products and investments. Any solution is likely to involve tax considerations and investment decisions and sometimes a compromise may be required.

It is also sensible to involve different professional advisers, for example, both a Financial Planner and a Trusts & Estate Solicitor who can work together to achieve a better outcome for you.