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How you’ve grown

As explained in last week’s article on the child trust fund, the initial payment of £250 is made to the CTF for all children born on or after September 1, 2002, with the top-up being made on their seventh birthday. Children who have their seventh birthday from September 1, 2009 onwards will receive the second £250 payment made directly into their CTF account.

In addition, payments of up to £1,200 a year can be made into the CTF account of any child. Additional payments can be made by any person, regardless of their relationship to the child, and the parental settlement income tax anti-avoidance rules do not apply.

It is estimated that if the maximum contribution of £1,200 (at the rate of £100 a month) is made every year for a child and growth of 7 per cent a year is achieved after charges of 1.5 per cent a year, then the fund would be worth around £37,000 on the child’s 18th birthday. And there is the worry for many would-be contributors. Under the CTF rules, the funds contributed would be held on a kind of “bare trust”, so the child would become absolutely entitled to the CTF account at age 18 and would be notified of their right. Especially given that, even in 18 years time, £30,000- plus would still be a large sum to hand over to an 18-year-old, many parents/grandparents would prefer to have a little more control – just in case.

There are a number of ways to deliver the desired control while retaining tax efficiency. The most obvious is for the contributor to contribute towards an Isa. The Isa cannot be assigned or set up in the child’s name but the proceeds would be tax-free (as would the investment income and gains accruing) and there would be absolute control for the Isa contributor. The proceeds could be used by the parental/ grandparental investor when they want and for whatever purpose they want.

The only thing that is missing is the formality of transferred beneficial ownership from outset. When any transfer of funds is made, this would represent a transfer of value for inheritance tax purposes. Where the transfer was outright, it would be a potentially exempt transfer to the extent that it was not covered by available annual exemptions.

Another option for would-be benefactors, who do not want to pass over absolute control to the child on their 18th birthday, is to invest in collectives held in a discretionary trust. The trustees’ annual CGT exemption could be used but trust income would be assessed on the trustees. Up to £1,000 per tax year of gross income would be assessed at the standard rate.

This would mean there would be no further tax to pay on interest received net of tax and dividends. To the extent that the grossed-up trust income in a tax year exceeded £1,000, it would be taxed at 40 per cent, 32.5 per cent on dividends. These rates increase to 50 per cent and 42.5 per cent respectively from April 6, 2010. Some may consider this too high a price to pay for control. Income distributed could trigger an element of tax reclaim – but not in respect of the non-payable 10 per cent dividend tax credit.

Where the settlor is the beneficiary’s parent, then any distributed income would be assessed on them.

The full capital gains tax annual exemption (of the child) could be secured if the investment were held subject to a bare trust and the income would belong to the child from outset.

However, the income would be assessed on the parent if the parent were the settlor, regardless of whether the income was actually paid to or applied for the benefit of the child, if it exceeded £100 gross in a tax year and the child is a minor who is not married or in a civil partnership. This would not be the case if the settlor were other than the minor unmarried beneficiary’s parent.

Even if the parent were assessed, though, it may be that the parent’s tax rate is lower than that suffered by the trustees. This may be especially likely in respect of income that exceeds the trustees’ standard-rate band but less likely for income of less than £1,000. The tax implications for any particular trust will depend on the facts and, especially for larger sums, will need to be carefully considered.

A simple and tax-effective option could be an offshore bond. This would deliver tax-free roll-up of income and gains and policy segments could be assigned to the child after their 18th birthday. The assignment would not trigger a chargeable event and any chargeable-event gain on encashment would be assessed on the assignee who could use any unused personal allowance to set against the gain. The assignment would represent a Pet for IHT purposes to the extent that the annual IHT exemption(s) were exceeded.

An alternative would be to hold the bond from outset subject to a trust. Provided the bond (or segments) in question were held on bare trust or assigned out to the adult beneficiary before encashment, then any chargeable-event gain would be assessed on the beneficiary (but see below). The transfer into the trust would represent a transfer of value for IHT and, to the extent that it was not exempt, would represent a chargeable or potentially exempt transfer, depending on the type of trust used.

There has been a comparatively recent change of interpretation on the taxation of chargeable-event gains on life insurance policies held on bare trust. Broadly speaking, the gain will be assessed on the beneficiary, regardless of age, provided that the settlor was not the child’s parent. If the child is under 18 and unmarried and not in a civil partnership and the gain is more than £100, then the gain will be assessed on the parental settlor.


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