Life is more expensive than ever for those aged under 40. University costs and house prices are high at the same time as job security is low, and workplace pensions are less generous than they used to be. So if you are a parent or grandparent, you may want to put money aside to help your children or grandchildren with major life costs. There are a number of different savings vehicles into which you can save for your children or grandchildren, and the ones you choose will depend in part on what financial costs you want the savings to cover.
Junior Isas
If you want to help with the costs of early adulthood, such as going to university, a junior individual savings account (Jisa) could be a good option. The money in this can be accessed when the child is 18, and you do not pay tax on the capital growth or dividends from assets held within it.
Only a parent or guardian with parental responsibility can open a Jisa, but other family and friends can contribute to it. There are two types of Jisas – cash and stocks-and-shares. You can open one or both for a child and the annual allowance is currently £4,368. This allowance cannot be carried forward into the next tax year, so you need to use it or lose it.
If you are investing over a long time period of 10 years or more, it makes sense to invest the money in a stocks-and-shares Jisa because over this timescale higher-risk and equity-based investments are likely to deliver a higher return than cash. Although they are likely to experience volatility along the way, because of the long timescale they have plenty of time to recover from market falls.
Rachael Griffin, tax and financial planning expert at wealth manager Quilter, says that if a child’s parent or grandparent invested the current annual Jisa allowance of £4,368 every year for 18 years, with an annual growth rate of 4 per cent after fees the money invested would grow to over £150,000.
Many investment platforms offer a range of Isa-eligible investments such as funds, investment trusts, exchange traded funds, shares and bonds. But you will also have to pay an annual platform fee, fund management fees and in some cases dealing fees.
Most investment platforms allow customers to invest small amounts on a regular basis, which can help to negate the risk of market timing. It also allows you more flexibility in terms of when you allocate money to a Jisa each year. If multiple family members plan to put money in, it can help to decide how much each person will contribute at the start of each tax year. Sixteen and 17-year-olds can contribute to their own Jisa at the same time as opening and saving up to £20,000 per tax year into an adult cash Isa.
As the money within a Jisa cannot be withdrawn until the child is 18, it cannot be used for short- to medium-term emergency costs. And when the child turns 18 they are free to withdraw the money from it – you have no control over the Jisa. “At age 18 a child can access the money [in their Jisa] and spend it however they want,” says Patrick Connolly, chartered financial planner at Chase de Vere. “This could mean that the money you put aside to pay for university fees or mortgage deposits could be squandered on foreign holidays and fast cars.”
However, Sarah Coles, personal finance analyst at Hargreaves Lansdown, adds: “Among our clients, the vast majority of Jisas remain invested after the child turns 18.”
When a child turns 18 their Jisa is automatically converted into an adult Isa.
Using your own Isa
If you are worried that your children or grandchildren will frivolously spend the money you set aside for them when they turn 18, you could save for them within your own Isa. “If you want to keep control, consider using your own Isa allowance before investing in a Junior Isa,” says Miss Griffin. “Contributions to an Isa in your own name could still be spent on your child [or grandchild], but you would retain control over when and how the money is spent.”
This is a good strategy if you are not using up all of your annual Isa allowance, which is currently £20,000. Once you set your Isa up anyone can contribute to it, so other family and friends could put money into it as gifts to the child. As with a Junior Isa, you do not pay tax on the capital growth or dividends from assets held within it.
Trusts
Another way to save for a child or grandchild is a trust. “Trusts are generally a good estate-planning tool for larger sums, and can allow parents and grandparents a good deal of control," says Jason Witcombe, chartered financial planner at Progeny Wealth. "But these benefits need to be weighed up against possible higher costs and complexity.”
There are two main types of trusts – bare and discretionary. The money in a bare trust can be accessed at any time by the trustees as long as it is used in the best interests of the child it is opened for. “This makes it particularly useful for costs arising before the age of 18, such as school fees,” explains Mrs Coles.
Anyone can set up and contribute to a bare trust, and there are no limits on how much can be put in. Anything you put into the trust can be exempt from inheritance tax (IHT) if you live for seven years after making the contribution. And bare trusts can be set up for free.
But, although the money in a bare trust is held in the name of the trustee, it legally belongs to the child. The money you put into a bare trust is an irrevocable gift, so you cannot withdraw it for your own purposes. It belongs to the child, who has the right to all of the capital and income of the trust at any time if they’re 18 or over in England and Wales, or 16 or over in Scotland.
And bare trusts are not tax-free. The money in them is legally owned by the child so they are liable for any tax on income or capital gains, but they can offset or mitigate this by using their annual personal income tax allowance of £12,500 or capital gains tax allowance of £12,000.
“However, parents need to be aware of the parental settlement rule,” explains Mr Connolly. “If funds in a trust originate from a parent for the benefit of their child, and the gross taxable income from them exceeds £100 per year, per gifting parent, the total income is taxed on the parent.”
For this reason, Mr Connolly often suggests investing in funds focused on capital growth, rather than income-focused funds which have a higher yield, as they are less likely to result in income exceeding the parent’s £100 income allowance. The parental settlement rule does not apply to assets given by grandparents or anybody else.
If you want to have control over how the money you give is spent, so it can be used for specific purposes such as buying a house or paying university fees, or want to hand it over when the child is at a certain age, then a discretionary trust might be a better option. These allow you to establish guidelines on how you would like the money to be used, meaning you can prevent the money you have passed on from being used for something you don’t approve of. When you set up a discretionary trust you have to appoint trustees who have to give their approval for the assets to be passed on to the beneficiary, although these can include yourself.
Discretionary trusts are also useful if you want to set up one account for a number of beneficiaries. “A discretionary trust can be set up for the benefit of a group of people,” says Jeannie Boyle, chartered financial planner at EQ Investors. “This is particularly useful for grandparents as the trust can be worded to include any future grandchildren, as well as those they already have.”
But setting up a discretionary trust is likely to require legal and financial advice, and there may be tax charges, so will incur greater costs and administration than some other types of savings vehicles.
Pensions for children
Workplace pensions are typically not as generous as they used to be and increasing financial pressures on young people mean they may give other financial commitments priority over pension contributions. But you could help your children or grandchildren get a head start on saving for retirement by investing in a junior self-invested personal pension (Sipp) on their behalf.
“The long-term tax benefits of pensions, plus the government tax relief, can make a compelling case for children’s pensions in certain circumstances,” says Ms Boyle. “A junior Sipp needs to be opened by a parent, but after that anyone can contribute to it.”
Although control of the pension passes to the child when they turn 18, there is no risk of them spending the money in it at that point because you cannot access pension assets until you are age 55, and from 2028 this is likely to be age 57. But this also means that pension savings for children are only suitable if they have other savings that can be accessed sooner.
Because of the length of time the money in a child's pension will be invested, it has the potential to grow substantially, so putting it into equity-focused investments is probably the best way to make the most of the long time horizon. You can pay in up to £2,880 a year to a child's pension and the government will contribute 20 per cent in tax relief, resulting in an annual contribution of up to £3,600. Due to compounding growth, even small contributions to a child’s pension can make a huge difference to the amount of money they will eventually have for their retirement.
Tom Selby, senior analyst at broker AJ Bell, says: “If you contributed £2,880 for the first 18 years of a child’s life, topped up with tax relief to £3,600, and it grew at an average rate of 5 per cent a year after fees, you would have £105,197 by the time the child is 18. If that pot continued to grow at the same rate, even without further contributions you’d have a £1m pension pot after a further 46 years, by the time the child is age 64.”
You can put money into a Junior Sipp as an annual lump sum, but some providers require a minimum monthly contribution. The maximum monthly payment you can make into a child’s pension is £240, which – with government tax relief – increases to £300. Making regular payments means your investments benefit from pound cost averaging. When markets go down your set investment amount buys more units or shares, and when they go up and are more expensive, it buys fewer.
Junior Sipps are also IHT-efficient because the money put into them can be treated as a lifetime gift which reduces the value of your estate.
But Junior Sipp providers such as investment platforms charge a range of fees, including for annual administration which can be a fixed charge or percentage-based. There may also be dealing fees, and if you invest the Junior Sipp in funds these will have charges too.
