Financial News Updates

University costs at your discretion?

December 14th 2009

A discretionary trust gives trustees total control over when and how the student receives financial assistance, to help with the payment of fees and ongoing living expenses. It is considered more appropriate than a bare or absolute trust, under which a student, on attaining age 18 (16 in Scotland), can legally demand their share of the trust fund and defeat the purpose for which it was intended. Although this may be considered to be unlikely, a discretionary trust will avoid any temptation. In addition to protecting the funds from any possible future creditors, a discretionary trust also affords the person(s) who created the trust with potential inheritance tax savings. Funding university costs by combining the income tax efficiency of an offshore bond with the IHT savings opportunity of gifting without reservation could therefore be a very tax efficient strategy

How does it work?

1. The parents and/or grandparents create a discretionary trust in which the student is included as a potential beneficiary. The trust allows the trustees to use the trust funds for the maintenance, education, or benefit of the beneficiary with others.

2. The parents and/or grandparents make a gift of capital to the trustees for the purpose of meeting the future cost of fees and ongoing living expenses. This gift will constitute a chargeable lifetime transfer for inheritance tax purposes. However it will usually be covered by an available nil rate band (£325,000 for 2009/10) consequently, the gift will be free from any possible inheritance tax after seven years.

3. The trustees choose to invest the capital into an offshore bond that offers a wide choice of investment opportunities and is divided into a number of individual policies or segments for greater tax efficiency. Any growth within each segment is generally tax free until, for example, a segment is encashed.

4. When there is a requirement for financial assistance, the trustees transfer individual segments to the student, which will not trigger an income tax charge. When the segments are subsequently encashed, tax on any gain is assessed on the student, which will typically be lower than if it had been assessed on the parent or grandparent.

5. For 2009/10, the student’s personal allowance of £6,475 can be used to offset any gain. A 10% starting rate for savings income would be payable on any excess up to £2,440 and any excess that falls within the basic rate threshold will be taxed at 20%.

The following example is for illustrative purposes only and does not take into account any charges. All figures are rounded to the nearest pound. Please note that the value of an investment in the bond can fall as well as rise, is not guaranteed and your client

could get back less than they invest.

Example

Howard and Jennifer, both aged 41 and higher rate taxpayers, are looking to set aside some money for their daughter’s future, including the payment of her university costs that are expected to start in five years. They have estimated the current costs to be around £12,000 a year with an increase of 4% each year and assume she will

graduate after four years. They consider investing £60,000 into an offshore bond and will encash individual £1,000 segments each year to contribute towards the expected university costs, fees and living expenses. They expect to remain higher rate taxpayers. Assuming an annual growth rate of 6% after charges for the bond:

End of year	Initial Value of Segments	Encashment Value	Gain @ 40%	Tax Payable	Net Proceeds	University Costs
5	£11,000	£14,720	£3,720	£1,488	£13,232	£14,600
6	£11,000	£15,604	£4,604	£1,842	£13,762	£15,184
7	£11,000	£16,540	£5,540	£2,216	£14,324	£15,791
8	£10,000	£15,939	£5,938	£2,375	£13,564	£16,423
Totals	£43,000	£62,803	£19,802	£7,921	£54,882	£61,998

But what if Howard and Jennifer instead create a discretionary trust which includes their daughter as a potential beneficiary and gift their £60,000 to the trustees, who would invest in the same offshore bond and withdraw the same amount each year as before? By assigning segments to their daughter, Howard and Jennifer could save £7,921 in tax to contribute more to their daughter’s future. Assuming she has no other income, the gain each year will be covered by their daughter’s personal allowance, resulting in a zero tax liability on total payments of £62,803. The remainder of the bond could be used to buy their daughter a car or help with a deposit for her first property.

This document is based on our current understanding and interpretation of current legislation in the UK and Ireland and HMRC and Irish Revenue Practice, which may change at any time.

‹‹ All Articles