Suitable Investments For Minor Children As Beneficiaries Of Trusts
Information in this article should not be taken or relied upon as personal financial advice. Any individual requiring information or advice on their own specific circumstances or on their own account should contact a suitably qualified professional.
As the taxation treatment of all trusts except absolute trusts is now relatively hostile with a 45% tax rate on income over £1,000 and 28% on capital gains, some care is required in selecting investments to minimise exposure to these charges. It may also help with lowering administration and accountancy fees for smaller trusts if HMRC reporting can be kept to a minimum and there is no need for beneficiaries to make tax reclaims which can be a relatively tedious process for under 18s who have no general experience of dealing with the tax authorities.
Assuming that the solution is not to simply appoint capital to the minor under bare trusts (not appropriate if the settlor was the minor’s parent), it is usually useful to consider Investment Bonds in an investment strategy, possibly in combination with National Savings tax free products and a small reserve of liquidity, the interest income in which will be within the £1,000 trusts’ tax allowance.
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Investment bonds which may be of the life assurance or capital redemption variety have these advantages:
- No dividends are paid, so no 45% tax liability and complicated reporting or tax pool calculations.
- The asset can be assigned out in segments (allowing part distributions) when the beneficiaries get to age 18. This can be very useful if the trustees use their powers to appoint capital while the beneficiaries are still not tax payers (for example, while at college/university). If an offshore bond had been used, it is possible that investment returns could be received totally tax free.
- There is no income reportable to HMRC if withdrawals are not made in excess of 5% per annum of the invested capital. The 5% allowance accumulates if unused, allowing quite large tax deferred withdrawals after a few years.
- The effective rate of tax will be about 20% on an ongoing bias for UK issued bonds, or nil for offshore plans. This should result in a faster roll up of capital growth and income, although that advantage may be wiped out if the bonds are encashed within the trust.
- Investment choice is very wide with plenty of risk controlled strategies available and low or even nil costs of altering investments (switching). An appointed financial adviser may also assist the trustees in setting and recording an investment policy and holding annual meetings in line with their obligations under trust legislation.
- The fact that bonds are usually issued in segments means that it is possible to appoint out benefits as bond segments under bare trust to a minor, cash the bond segment(s) at that time or later and have the chargeable event income tax liability assessed on the non-tax paying minor, instead of the original trustees of the bond.
There are disadvantages:
- The trustees cannot use their annual Capital Gains Tax allowance if they hold no other investments like shares or collective funds.
- The withdrawals from a bond using the 5% annual allowance are strictly of capital and will not satisfy a legal obligation to pay income, although if the trustees have powers to pay out/appoint capital, that will deliver the same effective result.
- Investment Bonds are regulated investment products and it will be necessary to pay an authorised financial adviser to set them up. However, ongoing financial reporting and trading costs may be lower than those applicable to stock broker managed portfolios, especially for sums below £500,000.
The trustees will need to review their obligations in terms of setting an investments policy and reviewing it, but a failure to consider the investment bond option would seem to be irresponsible.
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