Many parents worry about the retirement prospects of their children, especially with the uncertainty surrounding state pension provisions. While the future may look different in terms of government support and tax incentives, there are ways to start planning for a child’s financial future today. One such way is through a bare trust.
Unlike pensions, which have specific rules and tax reliefs that apply to individuals, a bare trust offers an alternative method for parents and grandparents to invest on behalf of children. Here’s everything you need to know about bare trusts, including how they work, their advantages, and some considerations to keep in mind.
What Is a Bare Trust?
A bare trust is a straightforward legal arrangement where assets are held by one or more trustees on behalf of a beneficiary, who is usually a child. The beneficiary, even though they are not yet of age to manage the assets, will eventually become the legal owner of the trust’s assets once they reach adulthood.
In practice, a bare trust allows the settlor (the person who sets up the trust) to give a gift of money, property, or shares to the child. The gift legally belongs to the child, but the trustees are responsible for managing and overseeing it until the child reaches the legal age to control the assets themselves. The trustees, which can include the child’s parents or grandparents, ensure that the money or assets are invested appropriately according to the child’s best interests.
Setting Up a Bare Trust
To set up a bare trust for a child, one of the most tax-efficient methods is through a life insurance savings or investment plan. These plans allow you to make a lump sum payment or contribute smaller amounts over time. The funds are managed by a life insurance company, which invests the money on your behalf, and you can select the level of risk and return that aligns with your investment goals.
Capital Acquisitions Tax (CAT)
In Ireland, the Capital Acquisitions Tax applies to gifts and inheritances, including those received through a bare trust. CAT consists of three types of tax: gift tax, inheritance tax, and discretionary trust tax.
The tax liability varies based on the relationship between the giver and the recipient. The thresholds for CAT are divided into groups, and if the value of the gift exceeds the applicable threshold, the excess is taxed at 33%.
- Group A: €335,000 (applies to children, stepchildren, or foster children).
- Group B: €32,500 (applies to siblings, parents, grandparents, nieces, and nephews).
- Group C: €16,250 (applies to all other relationships).
If the gift or inheritance is below the threshold, there is no tax liability. However, any amount above the threshold is subject to the 33% tax.
The Small Gift Exemption
The Small Gift Exemption allows individuals to give up to €3,000 per year to any person without incurring Capital Acquisitions Tax. This is an excellent way to gradually build up a gift for a child without hitting the tax threshold. For instance, parents, grandparents, or other family members can contribute to a child’s bare trust without triggering tax liabilities, as long as each gift remains under the €3,000 limit.
Advantages of a Bare Trust
There are several reasons why setting up a bare trust for a child is a popular choice:
- Flexibility: Bare trusts can be used to invest in a wide variety of assets, such as money, property, or shares.
- Tax Efficiency: By using the Small Gift Exemption and the capital acquisitions tax thresholds, bare trusts offer a way to transfer assets in a tax-efficient manner.
- Control: The settlor and trustees retain control over the investment, ensuring it’s managed responsibly until the child reaches the age of majority.
- Long-Term Growth: A bare trust allows for long-term investment growth, benefiting from compound returns over time.
- Probate Benefits: Assets held in a bare trust are generally not subject to the probate process, which can streamline the transfer of assets upon the settlor’s death.
Disadvantages of a Bare Trust
While bare trusts offer many benefits, they also come with certain drawbacks:
- Age Limitations: Bare trusts are only suitable for children under the age of 18. Once the beneficiary turns 18, they gain full control of the trust, which may not align with the settlor’s original intent.
- Irrevocable: Once a bare trust is set up, it cannot be revoked or altered. This means you need to be confident that you won’t need access to the funds or assets in the future.
- Ownership Transfer: Legally, the child becomes the owner of the assets placed in the trust. This means that while the money is being managed by the trustees, the child has the right to it as soon as they reach the required age.
Where to Find More Information on Pensions
If you’re also thinking about long-term financial planning and pension options, the National Pension Helpline can be a valuable resource. The helpline offers free advice on setting up pensions for your children, grandchildren, or other young family members, ensuring they are on the right path to financial security.
For anyone looking to explore pension options or seeking advice on how to best provide for a child’s future, reaching out to a qualified pension advisor can provide clarity and guide you through the process.
Conclusion
A bare trust offers a flexible, tax-efficient way to invest for your child’s future, whether for their education, business endeavors, or home purchase. By leveraging tax exemptions and carefully choosing the right investments, you can ensure that your child has the financial foundation needed for adulthood.
However, as with any financial decision, it’s important to weigh the pros and cons, and consider whether a bare trust aligns with your long-term goals. If you’re uncertain, consult with a financial advisor who can help you make the best choice for your family.