The dilemma faced by many generously-disposed grandparents is how to benefit their grandchildren financially without running the risk that they will squander the money.
The solution which immediately comes to mind is to set up a discretionary trust, which confers no rights on the beneficiaries but enables the trustees to make payments in their discretion.
However, discretionary trusts lack the tax-efficiency of bare trusts, which are tantamount to outright gifts but deny the beneficiaries title to the trust investments until they reach the age of 18.
Arguably, the best of both worlds could be achieved if the trustees of the discretionary trust were to exercise their right to make absolute appointments of the trust funds to bare trusts for beneficiaries under the age of 18. Any capital gain which had occurred since the discretionary trust was set up would then fall on the minor beneficiary, and their income tax personal allowance or capital gains tax exemption could be used to reduce or eliminate tax on the gain.
The appointments to the bare trust could be made to cover specific financial needs as they arose, and meanwhile the remainder of the trust funds would remain sheltered in the discretionary trust.
Dividends received on investments held in bare trust are accompanied by a tax credit, so basic rate taxpayers have no liability to income tax whether the income is received or accumulated. However, if the investments were transferred to grandchildren, they would be subject to capital gains tax on any increase in value since the date when the bare trust was established.
As an alternative to setting up a trust, parents and grandparents can buy Junior ISAs on behalf of their offspring. These are completely free of tax but the maximum annual investment is only £3,720 (increasing to £4,000 as from 1 July 2014).