The relief, called the normal expenditure out of income exemption, provides that if you have surplus income each year (that is, you do not have to spend all of your income in order to maintain your standard of living and income is effectively accumulated as capital), any gift made out of that surplus income passes immediately out of your estate without having to survive for seven years.
This not only means that there will effectively be no IHT liability on any payments but in addition, if you were to use that surplus income to fund a discretionary trust, there is no £325,000 limit on how much can be transferred into the trust.
The key to taking advantage of this exemption is to maintain the records of income, expenditure and gifts each year, rather than post-death having to reconstruct the last seven years of income and expenditure.
Trusts
A better option would be to create a bare trust for your grandchild. A bare trust is effectively a nominee arrangement for the grandchild: when under 18, the grandchild cannot have funds in their own name and so they are held in the name of trustees for their benefit and the funds would have to be spent for that grandchild’s benefit or invested for them.
If the sum is large enough, the trustees could invest the funds and draw down each year depending on school fees. If there was a balance left over upon completion of education, that would belong to the grandchild. It should be noted that at 18 the grandchild can require funds to be transferred to them, so consideration should be given to not handing over too much.
Trustees will typically be the child’s parents, but the grandparent who is providing the funds could also be a trustee to retain some control over the use of funds.
A bare trust does not, however, work where a grandparent wants to set aside funds for future grandchildren or wants flexibility as to how to provide for a group of grandchildren.
Here, a better approach would be to set up a discretionary trust for the benefit of all present and future grandchildren.
A discretionary trust can be looked at as a pot of assets managed by trustees (that you appoint) for the benefit of the trust beneficiaries (in this case grandchildren).
The trustees decide how the funds should be used for the benefit of those beneficiaries, both by deciding how to invest them and deciding how and when to make payments to beneficiaries.
Beneficiaries do not have to be treated equally. Such a trust would normally be accompanied by a Letter of Wishes from the settlor (that is, grandparents) setting out how they would like the trust to be used. The grandparents would appoint the trustees and could themselves be one of them.
