Many of us will still remember the Accumulation and Maintenance (A&M) trust, which was commonly used for education funding prior to the Finance Act 2006.
Under this type of trust a grandparent, for example, could put aside a lump sum for a grandchild or grandchildren. The trustees were able to accumulate the income until a certain date (usually a 25th birthday), at which point the beneficiary or beneficiaries became entitled to the trust property or at least the income arising from it. Before that time, subject to the terms of the trust, the trustees could use income and capital for the maintenance of the beneficiary, hence the name accumulation and maintenance trust. A key advantage was that the original transfer into trust at outset was a potentially exempt transfer for inheritance tax (IHT) purposes.
These trusts were popular with some solicitors and were mainly used for school fees planning. The grandparents could gift capital to the trust as part of an estate planning exercise, knowing that their grandchildren would benefit from that capital. In addition, it would provide the grandparents, through the trustees, with an element of control over how and when benefits were payable before the grandchild reached the specified age.
As part of the Finance Act 2006, the IHT efficiency of A&M trusts changed. Any A&M trusts established before 22 March 2006 maintained their favourable IHT treatment provided the beneficiary became absolutely entitled at age 18. This meant in most cases that the terms of the trust had to be changed and the trustees had until April 2008 to do so, otherwise the trust would become subject to the relevant property regime and be taxed in a similar way to a discretionary trust.
Alternatively, the trustees could convert the trust to an age 18-25 trust. An age 18-25 trust was a new trust which was introduced as part of the Finance Act 2006 changes but, unlike new and unchanged A&M trusts, they are only potentially subject to an IHT exit charge at a reduced rate when the beneficiary becomes entitled between the ages of 18-25.
So what IHT-efficient arrangements are available to those who want to make provision for grandchildren now?
A controlled access trust is designed as an alternative to the old A&M trust and can form part of an estate planning solution. Some may not be familiar with how this type of trust works.
Like an A&M trust, grandparents may decide to gift money for the benefit of a grandchild as part of an estate planning or school fees exercise. However, not only are they seeking IHT-efficiency, but they also want to make sure that there is control over how and when the grandchild can benefit.
At outset, the grandparents will create a bare trust with the grandchild as beneficiary and gift a lump sum to the trustees for them to invest. This is a potentially exempt transfer for IHT purposes meaning that the gift may only be liable to IHT if the grandparents die within seven years. Furthermore as the trust is a bare trust (and if the parental settlement rules do not apply) any chargeable gains are assessed on the beneficiaries.
The trust is structured so it has two beneficiaries: the named grandchild, who must be under the age of 18, will be entitled to 99% of the benefits and an adult beneficiary (perhaps the 99% beneficiary’s parent) will be entitled to the remaining 1%. Under the rules of the trust, the trustees cannot change the beneficiaries or the split of benefits each beneficiary will receive.
The trustees then invest the lump sum across a series of policies with defined maturity dates and no surrender option. These policies can be structured in such a way as to provide the trustees with periodic lump sums which can be used for expenditure, such as school fees.
There are options available to the trustees and these depend on the age of the grandchild.
Before the grandchild’s 18th birthday
The maturity proceeds are held absolutely for the beneficiaries so, if any policy reaches its maturity date, then the proceeds are available to the trustees to pass on to the beneficiaries.
The adult beneficiary can gift away their entitlement to their 1% share of any benefits and, although this will be a gift for IHT purposes, it could utilise all or part of their £3,000 annual allowance (if they have not used this elsewhere). The trustees are then able to use the proceeds, possibly to pay for or contribute towards education fees.
If the funds are not required then the trustees have the ability to defer the maturities to a later date. The trustees must defer before the maturity date.
This option to defer the maturity dates is designed to provide the trustees with flexibility to control the timing of when any benefits are distributed to the beneficiaries.
Immediately before the grandchild’s 18th birthday
The policies within the trust cease to be deferrable after the grandchild’s 18th birthday. Therefore, the trustees need to consider the maturity dates for any remaining policies in the trust.
There can be a number of life events that the trustees may wish to consider and the maturity dates can be chosen to coincide with these. They may decide to set the maturity dates to provide payments when the grandchild finishes university, to provide them with a contribution towards a house deposit at some point, fund a gap year and so on. As there could be a number of policies remaining at that time, the maturity dates could be staggered to cover a number of objectives.
After the grandchild’s 18th birthday
As the controlled access trust is a bare trust, once the child beneficiary reaches 18 they and the adult beneficiary can dissolve the trust and take their share of the trust property. The inclusion of the adult beneficiary coupled with the structure of the arrangement means that the grandchild cannot terminate the trust without their agreement, restricting the ability to exercise their right under the Saunders v Vautier ruling. It can also prevent the child beneficiary from securing a loan against the proceeds.
In addition to this, as the policies do not have a surrender option they have to be retained until the maturity dates set by the trustees.
On the final maturity date, the beneficiaries have the option to defer the maturity date further, although this cannot go beyond the grandchild’s 49th birthday, or have the policies endorsed so that they can take either lump sum or partial surrenders.
When gifting money for the benefit of a grandchild, the donors will want to make sure that there is an element of control over the timing of the benefits. The structure of a controlled access trust helps to provide this with a degree of IHT-efficiency. As there can only be one child beneficiary for each trust a separate trust has to be used for each grandchild that provision is being made for.
As the initial gift is made into a bare trust there is no IHT payable on entry, whatever the size of the investment, and no 10-year anniversary periodic charges to worry about. It is treated as a potentially exempt transfer and is therefore outside of the donor’s estate after seven years. If the original gift is in excess of the nil rate band and death occurs within seven years then taper relief may apply to reduce any IHT payable. Unlike other bare trust arrangements, the controlled access trust allows the benefits to be held back until after the grandchild’s 18th birthday.