- There are several ways to invest for children
- Starting early will save tax in the long run
- Ensure your own financial security before setting money aside for children
French fashion designer Coco Chanel is reputed to have coined the phrase “the best things in life are free”. You might not be surprised to learn that she didn’t have children.
If you want to invest for your children or grandchildren, the most efficient way of doing this is to start when they are young. A small amount set aside each month over several years can compound into meaningful savings that could be used for large costs such as a deposit to buy a home or university expenses.
A survey of people setting aside money for their children by investment platform Hargreaves Lansdown (HL.) found that 57 per cent of them put it into a cash savings account in the child’s name, 35 per cent into a cash Junior individual savings account (Isa) and 25 per cent into a savings account in their own name.
Only one in 10 opened an investment Junior Isa and just 3 per cent invested in their child’s name, usually within a bare trust.
UK-resident children can earn up to £18,570 of savings income per year before tax is payable, assuming they have no other taxable earned income, says chartered financial planner Kay Ingram. This is because of the £12,570 personal allowance, 0 per cent tax savings rate of £5,000 and £1,000 personal savings allowance. Children also have the same dividend and capital gains tax (CGT) allowances as adults of £2,000 and £12,300 each year, respectively. However, if the source of funds is a parent, income over £100 is taxed as the parent’s income. This does not apply to grandparents.
Before you start investing for any dependents, ensure your own future financial security.
Junior Isas
Junior Isas can be efficient wrappers within which to save for your kids. At present, you can invest up to £9,000 a year in a Junior Isa until the child reaches age 18. At this point, the Junior Isa becomes an adult Isa, meaning that the assets within it continue to be in a tax-efficient environment. Junior Isas can only be opened by a parent or legal guardian, but others can contribute to them.
Carla Morris, financial planner at wealth manager Brewin Dolphin, points out that the annual £3,000 gifting allowance can be used to fund a Junior Isa. She adds that contributing the full allowance of £9,000 – or £750 per month – for 18 years to an investment Junior Isa, could create a fund of £240,000, assuming a return rate of 4 per cent net of fees.
However, when the child in whose name the Junior Isa is held turns 16 they can take control of the account and decide where it is invested. And when they turn 18 they have access to the account. So while this is an opportunity for them to learn how to invest responsibly, it may not be not suitable if you want to keep control of the account after they turn 18.
When children are ages 16 and 17, they can have both a Junior Isa to which up to £9,000 can be contributed in both years and a cash Isa into which up to £20,000 can be saved in both years. From age 18, up to £20,000 a year can be invested in their Isas.
You are not able to take money out of a Junior Isa until the child turns 18 other than in exceptional circumstances. And in most cases they are not particularly effective for cash or low-risk accounts, unless the source of funds is a parent who has used up their own personal savings allowance of £1,000.
“Taxable children’s savings accounts often offer a better rate of interest than Junior Isas,” says Ingram. “For example, the best cash Junior Isas currently offer 2.5 per cent interest, whereas leading children’s savings accounts offer 3 per cent on lump sums and 3.5 per cent on regular savings. Children only pay tax on these savings if they have income of over ££18,570.”
Investment Junior Isas are more likely to meet longer-term investment needs. But, unless a parent is funding them, they are unlikely to offer any tax advantages unless income is expected to exceed the child's personal tax allowances or gains above the £12,300 annual allowance are realised.
Pensions
If you are concerned about a child accessing their money at a young age, you could invest in a personal pension for them. Children without earned income can save up to £2,880 a year into a pension and will receive 20 per cent tax relief on top of that, taking it to £3,600. Investments in pensions pay no tax on income and growth while rolling up and are outside an individual's estate for inheritance tax (IHT) purposes.
However, the child will not be able to access their pension until they are 57 – or older if the rules change. Third-party contributions into the pension can continue beyond when the child is 18 and can be worth up to £40,000 a year, or what the pension plan owner’s earned income is, whichever is lower.
“Starting a pension may be beneficial if children are already in their teens or take time off work to care for family members and miss out on workplace pensions,” says Ingram.
Rosie Hooper, chartered financial planner at Quilter, says that Junior self-invested personal pensions (Sipps) should “almost always be held in equities” to ensure that they grow. Because of the long investment time horizon, they can ride out periods of volatility.
The pensions lifetime allowance is currently £1,073,100 and something to be mindful of if you are paying into a child’s pension. Money in a pension above this value can incur a charge of 55 per cent or 25 per cent if you withdraw it, depending on how you take it out, and on your 75th birthday. Hooper says that the lifetime allowance could easily be breached if there are regular contributions into the pension and there is strong investment growth.
“Making your child aware of this once they begin their working life will give them the best chance to ensure that they navigate the tax landscape effectively and do not end up paying more tax than they have to," she says.
Trusts
A bare trust, which can be set up on several platforms, can be a tax-efficient way to invest money on a child’s behalf, especially if you need access to the money before the child is 18, for example to pay school fees. Your payment into a bare trust is a potentially exempt transfer so, as long as you survive seven years after making it, there is no IHT. There is no limit to the amount that can be paid into the trust.
If bare trusts pay income to the child before they are 18, the child’s income and CGT allowances can mean that the withdrawals are tax-free, if the amount falls within their annual limits.
Children can access the money in their bare trusts when they turn 18. With larger amounts, and if access at 18 is a concern, a discretionary trust might be better. These also work well if it is possible that there will be more than one beneficiary, such as unborn grandchildren. The trustees can maintain control over distributions, which might help them safeguard vulnerable beneficiaries and keep on top of their tax allowances. Read more on this in Tax planning and the role of trusts (IC, 1 October 2020).