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The university of life

When children go to university life for their parents can work out to be extremely expensive. This is especially true if parents are having to pay the costs from taxed income.

The costs usually include a contribution towards the normal living expenses of the children and currently, for most of the UK, also include tuition fees – although this may change.

This article looks at a way in which the costs can be met in a possibly much more tax-efficient manner, if circumstances are favourable.

It is usually the wealthy client who benefits, as the planning involves the use of some capital set aside for the purpose in advance of the costs actually arising. Tax planning is, after all, invariably better eff-ected early rather than late.

The first problem to consider is that any gift by a parent to a minor child can be deemed a parental settlement. Any income arising on the capital representing the gift will be assessed on the parent if that income is more than £100 per annum.

This used to be able to be overcome by a parent gifting capital into a bare trust for the minor child, with the statutory provisions for advancing any of the capital for the benefit of the child or income of the trust being appointed to the child before they attain majority being excluded.

In this way, the personal allowance of the child could be used against the income of the trust each year. Thus, this planning would be very tax efficient if, as was likely, the child had, for example, no other assessable income.

The annual capital gains tax exemption of the child could also be utilised – although this has become more difficult since the legislation against “bed and breakfasting”.

Since March 9, 1999, for any new trusts or new money to existing trusts, this planning no longer works as far as income tax is concerned.

So, what can be done?

Planning can still be effective as long as no income arises to the trust from the investment until the child reaches majority. This could mean the use as an investment of a single premium bond – preferably offshore to obtain the advantage of the near gross roll-up whilst the investment is building.

The bond could be subject to a power of appointment interest in possession trust created by the parent with the appropriate child having the interest in possession.

The trust would not need to be “bare” and this would have the distinct advantage that the beneficiary child could not just close the trust and take all the funds immediately on attaining majority.

However, the trustees could make absolute appointments of segments of the bond annually to the beneficiary once that beneficiary reaches majority. The segments could then be advanced to the beneficiary for no consideration.

The beneficiary could then encash these segments, making sure, for example, that the personal allowance and 10 per cent income tax band were not exceeded in respect of the gains on those segments.

If the child had no other income, then, for example, using 2001/02 tax rates, gains of £6,415 could be realised with a total tax liability of £188. The personal allowance of £4,535 and the 10 per cent income tax band of £1,880 would have been used. This would result in an overall tax rate on the gain realised of 2.93 per cent.

The funds realised could be used by the child to pay for the annual costs whilst at university. More than £6,415 could actually be realised tax-efficiently as this figure only represents the gain.

The amount that could be realised depends, of course, on the length of time that the investment was in force before encashment and also the level of growth.

Should the investment remain in the hands of the parents then it may be that any growth, be it income or capital gain, could be taxed at 40 per cent – so the 2.93 per cent outlined above looks particularly attractive.

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