An Educational Trust is very similar in many ways to a Family Trust – it just has a more specific purpose, and as such is generally simpler.
As the name suggests, an Educational Trust is setup with the express purpose of funding someone’s education. This could be private school fees, but more usually university fees and living expenses. Most UK universities now charge tuition fees at a rate of £9,250 per annum. In addition to this, most students will need to live away from home and rent some sort of accommodation as well as meeting their day to day living costs. According to the well-known website savethestudent.org the average cost of a three-year degree is £55,620.
For grandparents (it is usually grandparents who set up Educational Trusts, although anyone can) who have money, setting up an Educational Trust to meet the cost of fees makes very good sense as the trust fund is ring-fenced for that purpose, protecting it for example from the bankruptcy of a child’s parent or the fallout from a divorce et cetera, and there are also tax advantages.
The underlying trust in an Educational Trust arrangement will vary depending on the circumstances of the settlor(s) and the predicted circumstances of the beneficiary. It could be: a Discretionary Trust, common if the trust is to benefit several children – particularly children not yet born; an Interest in Possession Trust – only commonly used if the beneficiary is going to start drawing out money immediately; an Accumulation Trust – very commonly used; or even in some circumstances, a Bare Trust. The type of trust is not set in stone and it will always depend on individual circumstances.
As an example, a settlor who sets up a lifetime trust for his minor grandchild (beneficiary) with the aim of applying the income during the grandchild's minority (i.e. while they are under 18) will be taxed as if that income was their own income (i.e. income of the settlor). However, a settlor is able to create a trust and accumulate the income until the child reaches 18. Once a beneficiary attains adulthood, the income applied to them becomes taxable on them individually and ceases to be taxed on the settlor. For most university students this will be their only income so up to £12,500 (2020/2021) will not be taxed.
A settlor can put up to £325,000 into this trust or an amount equal to their unused inheritance tax (IHT) threshold. By doing this an individual reduces their own estate by £325,000 thereby potentially saving 40% tax on this amount (£130,000). Provided the settlor survives seven years, their IHT threshold is reinstated and therefore they will be able to settle a further £325,000 into trust after that seven year period should they wish to.
Income payments from a trust are paid net of income tax to the child. The child can thereafter reclaim some or all of the tax paid by the trustees via their own personal allowances. Where a trust has not been set up, the assets remain within the settlor’s estate and it is probable that the settlor may currently be paying university fees net of income tax (potentially at the highest rate of income tax, which is not recoverable). Therefore by placing the income producing assets into trust they are able to make the provision for university fees more tax efficient.