March 21, 2023


With the cost of private schooling for many families being their most expensive outlay, many grandparents are considering how they can assist their families with this expense and will want to consider tax efficient ways to pay for the school fees.

One way is to use a trust which can be a very useful tool in overall inheritance tax planning. This article explains how this might work.

What is a trust? A trust is an arrangement whereby a person (settlor) gives assets to another person (a trustee) who holds property for the benefit of others (beneficiaries).

Trusts allow settlors to gift assets out of their estate without making an outright gift to an individual. This can be useful to safeguard family assets by allowing a beneficiary to benefit from the assets without the asset being owned by them. This is particularly beneficial where the beneficiary may be considered too young to own the asset outright.

Trusts used for the payment of school fees would usually be discretionary in form. What this means is that trustees would be given the discretion to decide who, when and how a beneficiary benefits from a trust. The class of beneficiaries could include children and grandchildren. For example, the settlors could settle a rental property on trust. The trustees could continue to let the property. The rental income could be distributed to beneficiaries or direct to a school to settle school fees.

Trustees would normally have the discretion to distribute either income or capital to beneficiaries. Trust income would be amounts received for rents, dividends or interest etc and capital would be the original investment plus any capital growth.

There are tax consequences for settlors, trustees and beneficiaries but if structured the right way, they can be very tax efficient.

Settlors tax position: on creation of the trust there is a potential charge to inheritance tax on the amount gifted. However, there is a nil rate band which is the amount which an individual can gift to a trust without incurring an inheritance tax liability. This assumes that other similar gifts have not been made in the preceding 7 years. If the Settlor survives at least 7 years from the date of the gift, then those assets are removed entirely from the settlor’s estate. For a couple, this saves Inheritance tax of £260,000 in their estate (£650,000 * 40%).

When a settlor gifts an asset to a trust, the settlor is treated as disposing of that asset at market value and potentially capital gains tax is due. There is no capital gains tax on the gifting of cash and there is a potential postponement of capital gains tax by way of holdover whereby the trustees take on the asset at the settlors base cost, therefore postponing any capital gains tax charge.

Trustees tax position – the trustees are charged to income tax and capital gains tax on income and gains arising in the trust and may need to complete an annual income tax return. Any income tax paid by the trustees is used as a tax credit when income payments are made to beneficiaries. Depending on the tax position of that beneficiary, they may be able to claim some or all of that tax credit tax back from HMRC. Trusts can be very income tax efficient when there are beneficiaries with tax free allowances available e.g., grandchildren.

Most trusts will also have a periodic charge to Inheritance tax and when any capital is distributed to a beneficiary (known as a proportionate charge). The maximum rate is 6% on the value of the trust at the time and is only levied on the value of the trust which is in excess of the nil rate bands which were available on the creation of the trust. There are tax reliefs for certain assets and if the trust is structured in the right way, utilising reliefs and nil rate bands, then the charge can be minimised.

If you would like more information or advice on setting up a trust to pay school fees or as part of your tax planning, then please do get in touch.


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