Setting up a trust to fund a child's education

  • Identify different trusts appropriate to fund a child's education
  • Explain benefits of bare and discretionary trusts
  • Explain how trusts are taxed

Therefore, it wouldn’t be unreasonable to assume that grandparents falling within in this age category could be thinking about providing for future generations. 

What type of trust should I set up?

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So it is important to consider the type of trust to suit the needs of the family.

Different trusts have different tax consequences. Beneficiaries’ rights to the income and capital of the trust fund will also differ among different trusts.

There are three main trusts which could be appropriate in setting up a trust to fund a child/grandchild’s education.

  1. Bare trust
  2. Discretionary trust
  3. Interest in possession trust

Bare trust

A bare trust is essentially a nominee arrangement and the children/grandchildren are deemed to own the assets of the trust for tax purposes. 

Any income arising under a bare trust arrangement is treated as though it belongs to the beneficiary and therefore becomes taxable on them.

Given that the beneficiaries in these circumstances are likely to be minors and are unlikely to have other income, the bare trust arrangement allows them to use their tax free allowances such as the personal allowance, savings rate allowance and dividend allowance.

This is perfect for grandparents who wish to transfer income producing assets to the grandchildren where the donor is not a basic rate taxpayer or where the donor wishes to reduce the value of their estate for inheritance tax (IHT) purposes.

However, care should be taken where parents are setting up bare trusts for their minor children as anti-avoidance legislation taxes any income arising on the parents so this may not be tax efficient.

If the trust is used to fund university fees and consists of non-income producing assets with the expectation of capital gains at a later date, then this would not be an issue.

The downside to setting up a bare trust is that the beneficiary is entitled to take control of the trust assets at age 18.

The parent/grandparent may not wish for the minor to control these assets at such a young age.

A discretionary trust or an interest in possession trust may therefore be more appropriate.

Discretionary trust

It is more flexible as it gives trustees discretion to pay income or capital to the beneficiaries.

Unlike a bare trust, there is a class of beneficiaries who can benefit from the trust and these beneficiaries are not entitled to the assets of the trust upon attaining 18 years.

The anti-avoidance provisions which apply to parents setting up a bare trust also apply to discretionary trusts.

The only difference is that the income will become taxable on the parents on distributions to the minor child instead of being taxable on the income as it arises.