Structuring the bank of mum and dad
Over two-thirds of adults aged under 28 believe they will receive financial support from their parents towards significant life expenses such as buying a home. This is part of a wider change in parent-child dynamics for this Gen Z cohort, with 64% of Gen Z adults turning to their parents for financial advice, in contrast with older generations who prefer to consult professionals or online resources.
Cross-generation collaboration often involves setting up family trusts, which facilitate inheritance tax (IHT) mitigation for parents whilst enabling children to plan for major expenditure, including buying a property. A typical structure involves parents, as the settlors, establishing a fully flexible discretionary trust for the benefit of their children, grandchildren and remoter descendants (the beneficiaries). Beneficiaries of a discretionary trust have no automatic entitlement to income or capital. Instead, the settlors’ chosen trustees have wide powers to manage the trust assets for the beneficiaries’ benefit. To retain control over decisions regarding the retention or distribution of trust funds, parents can either act as sole trustees or as co-trustees alongside family members, trusted friends or professional advisers. If independent trustees are appointed, settlors can sign a letter of wishes to guide the trustees in the management of the trust fund.
Although the trust can be funded in various ways, parents with excess capital should consider using their available IHT nil rate band (currently £325,000 per person), the maximum amount an individual can transfer into trust without triggering an up-front IHT charge at the rate of 20%. Therefore, a married couple could jointly settle £650,000 into trust without any immediate charge to IHT.
Current rules mean that where a settlor survives their gift by seven years, the entire value of the gift will fall outside of their taxable estate for IHT purposes. Further, any growth in the capital value of the fund from the date of the gift is held outside the settlor’s taxable estate. After the seven years, the settlor’s nil rate band refreshes in full so they could re-use this, including by gifting another £325,000 into the same trust.
On expiry of the seven-year period, the gift facilitates a tax saving of at least £130,000 on death, based on IHT at 40% on the £325,000 nil rate band sum. Even if a settlor dies within seven years of their gift, the IHT on their death would be no more than if they had not made the gift. If they survive the gift by at least three years, their estate will benefit from taper relief, reducing the IHT rate charged on the gift on a sliding scale. The seven-year rule and taper relief remain untouched by the Government, but there have been suggestions that the seven years could be increased to ten.
Broadly, once set up, discretionary trusts are subject to the relevant property regime for IHT purposes. Although the rules are relatively complex, the basic principle is that (subject to any reliefs) the value of the trust fund is taxed every ten years (ten-year anniversary charges) and when capital is distributed to beneficiaries (exit charges). Under current rules, the maximum rate of IHT on such events is 6% of the value of the trust fund which exceeds the trust’s nil rate band.
Many other factors are relevant to setting up a trust, particularly where properties are involved, not least capital gains tax (CGT), stamp duty land tax, income tax, gifts with reservation of benefit and ongoing administrative costs. Advice should be taken to ensure that all elements are considered for an individual settlor’s situation, particularly as the tax position for trusts can vary significantly if minor children are involved.
Although we are focussing here on using trusts to buy residential property, commercial property can also be held in trust. This may be more attractive now due to the Government’s planned changes to the IHT treatment of private pensions. Previously, private pensions were outside the scope of IHT, which led to individuals purchasing commercial property via their pensions. However, from 6 April 2027 pension assets may be subject to IHT at 40% on the pension holder’s death. One consequence of the new rules (though this remains to be seen, given the current uncertainty) could be individuals instead involving trusts in commercial property purchases, which may be advantageous for income tax purposes. Income generated by commercial property held in trust is subject to income tax at the trust rates. Once distributed, discretionary beneficiaries receive this income with a 45% tax credit. Higher rate, basic rate, and non-taxpaying adult beneficiaries can then reclaim all or part of the tax paid at the trust rate.
Parents often want to balance offering financial support with retaining control over the use of gifted funds. Control can be exercised by withholding trust distributions until the parents, either as trustees or as settlors guiding the trustees by their written letter of wishes, are satisfied that their children will use the funds responsibly. Distributions for a property purchase can be structured in several ways, including:
- An outright distribution of cash (which could represent accumulated income generated by investment property in the trust) to a beneficiary, who will be free to spend it as they wish. This involves the least amount of control and the highest level of trust; the trustees cannot direct the beneficiary to use the funds for a particular purpose, such as a house purchase. However, the key benefit to this option is simplicity. The beneficiary can buy a property in their own name without any ongoing obligations to the trust.
- A loan (interest-free and repayable on demand) from the trust to a beneficiary. This allows the beneficiary to buy a property directly, whilst the trustees maintain control over funds loaned by the trust.
- Co-purchasing the property with a beneficiary. The trustees would hold a direct interest in the property which gives significantly greater control, but inevitably at a higher cost.
- Purchasing a property outright (i.e., without the beneficiary involved as a co-purchaser), and holding it as an asset of the trust. The relevant beneficiary could be given the right to occupy the property as their main residence rent-free, or for a nominal or market rent to claim principal private residence relief for CGT purposes. This involves the highest level of control; the property will not belong to the beneficiary. An advantage is that the property will not form part of the beneficiary’s taxable estate.
The settlors’ children may all be included as trust beneficiaries, so the same trust could be used to fund multiple purchases. Trusts provide flexibility; trustees can decide whether the same approach should be used for all beneficiaries and presented as a family standard, or whether each individual’s circumstances will be taken into account when making distributions.
Introducing a partner into the equation brings further considerations for older Gen Z’s. Parents with concerns over the longevity of such relationships can use their greater involvement to ensure the relevant beneficiary has implemented appropriate protections when purchasing with their partner. With 33% of Gen Z adults reporting that they would use financial support to buy a property outright, and 32% reporting they would use financial support towards a mortgage deposit, the value of this bargaining chip for parents as settlors and/or trustees is only strengthened.
In a property purchase scenario, the trustees could work with the beneficiary to ensure the beneficiary enters a restriction on the title, signs a cohabitation agreement with their partner (in the case of a home) or signs a Declaration of Trust to confirm the ownership split between co-purchasers, particularly where the partner is providing a smaller financial contribution. Open discussions around these protections organically lead into conversations about pre-nuptial agreements. These topics may not come as any surprise to the children: 56% of Gen Z adults reported that if they were to receive financial help or inheritance, they would expect strings attached to the gift.
Clearly both parents and children should seek professional advice before embarking on any of the above options to ensure all tax planning opportunities can be grasped and potential pitfalls avoided, particularly where a property is to be occupied as a beneficiary’s marital home. However, with parents being by far the most popular source of information and support for Gen Z’s financial planning, there is a welcome opportunity for families to talk more openly than was perhaps the case between previous generations.
First published in EG Magazine (8th March edition)
