Rising inflation and relatively low, though increasing, interest rates are a concern to parents looking after savings for their children, particularly where these are held in junior bank or building society accounts which is often the case.
To maintain the spending power of money gifted to children, investment choice is important. Equally, the choice of tax wrapper and/or ‘trust’ arrangement used is also key.
Providing a tax-efficient solution may be front of mind for most, but there are other aspects that influence choices, such as controlling a child’s access to savings, limits on how much can be saved, or even the administrative simplicity of a plan.
Savings for children usually come from parents and/or grandparents, but could be from any third party. Options range from children’s bank accounts, JISAs, and savings held in trust, to junior pension plans. The solution for any client may include one or more of these, depending on the motives behind saving.
Junior ISA (JISA)
The main attraction of a JISA is that interest, dividends and capital gains on savings are tax-free.
Although a JISA can only be set up by a parent or guardian, the tax-free status means parents don’t have to worry about the ‘£100’ parental settlement rules that may apply to other investment vehicles. HMRC have also confirmed that a JISA doesn’t have to be registered on the TRS (Trust Registration Service).
While only parents (or guardians) can create an account, gifts can be made by anyone. These will be PETs, Potentially Exempt Transfers, so there are no immediate IHT consequences. An account cannot be opened for a child who has an existing Child Trust Fund (CTF) but it is possible to transfer a CTF into a JISA.
Investment can be made into both cash and stocks and shares and in any proportion, but there is a total annual subscription limit of £9,000 per child. However, from age 16 children also qualify for the adult cash ISA, meaning that they can contribute up to £29,000 into ISAs at ages 16 and 17. Contributions to the JISA must, however, be made before turning 18 in a tax year.
On reaching age 18, a JISA converts into an adult ISA. The child can then operate their own account, choosing investments and potentially new providers. This may be an opportunity to transfer any adult cash ISAs accumulated at ages 16 and 17 into stocks and shares ISAs to help combat inflation.
But this loss of parental control may be a concern as children can also spend their savings in a way that their parents do not approve of. Up until 18, withdrawals are not normally allowed and cannot, therefore, be used to meet, say, private schooling costs for under 18s, but conversely can provide a pot to help with further education costs post 18.
Saving into a trust
Making gifts to a trust is another way to save for children, and there is no upper limit to how much can be paid in. This route ideal is for larger gifts, maybe alongside a JISA. But there are several things to watch out for.
A discretionary trust is a solution to the ‘control’ issue as trustees make the decisions over when funds can be paid out. This means children cannot access money when they are 18, but trustees can make payments out at appropriate times – for example, for the deposit on a house or to help with educational fees, whatever the age of the child.
Donors need to be aware that gifts into these trusts are chargeable lifetime transfers and so could incur a charge if they exceed their nil rate band and are not covered by any exemptions.
A bare trust could be used instead and, as gifts are potentially exempt transfers, there’s no immediate IHT charge, opening up the possibility of gifts in excess of the donor’s nil rate band. But again the downside is that the intended child would be able to access the money at age 18, which may be even less desirable where the gifts are of significant value. However, trustees would normally be able to use the trust fund for the child’s benefit when they were still a minor – for example, for school fees. JISA funds cannot be used in this way.
Unlike a JISA, trust investments are not tax-free. Discretionary trusts with annual income over £1,000 pay tax at 39.35% on dividends and 45% on interest, as well as the upper rate of Capital Gains Tax on asset sales. Trustees will have to complete a self-assessment return each year.
Bare trusts are more tax-friendly, with income and gains (including chargeable event gains on bonds) assessed on the beneficiary. There may be no tax to pay if income and gains are within the beneficiary’s allowances. It should be remembered, however, that when a trust is created by a parent all income will be taxed on that parent if it exceeds £100 a year. But note that this rule does not apply to grandparents.
By investing in investment bonds, discretionary trustees can defer tax and potentially avoid the need for completing self-assessment on the trust. Ultimately, bonds or bond segments can be assigned (gifted) to the beneficiaries, or else cash payments made to them if withdrawals are taken within the 5% tax deferred allowance.
Whatever the investment and whichever type of trust is used, trustees will still have a responsibility to register with the Trust Registration Service and keep it updated.
Saving into a child’s pension is a tax-efficient option with tax relief available and both income and gains on investments are tax-free. It also eliminates any concerns that a child can spend their money when they’re too young as they can’t access it before the minimum pension age, currently 57 for today’s children.
By the same token, this is not a solution for those who wish to help children with certain life events, such as getting on the housing ladder. It’s very much about building a fund for their retirement, perhaps encouraging children to continue to pay in once they themselves become an adult.
As most children have no earnings, total contributions will be limited to £3,600 a year gross, and £2,880 net.
This amount falls comfortably within the £3,000 IHT annual exempt amount if this has not been used elsewhere. Alternatively, the gift could be exempt if it’s made regularly from excess income. In the absence of any exemptions, the gift would be a potentially exempt transfer.
OEICS and designations
Savings into unit trusts and OEICs cannot be held in a child’s name. They must be held by an adult. While some funds may allow applications to be made with a ‘designation’ to a child, HMRC may contend that this is not a bare trust for tax purposes.
If this is the case, the danger is that there is no gift for IHT, and income and gains will be assessed on the adult applicant. The gift would only be made when the investments are eventually transferred to the child at 18 along with the liability to Income Tax and Capital Gains Tax, although the transfer itself would be a disposal for CGT. If HMRC did accept that a designation was irrevocable and constituted a trust, such arrangements may require registration with the TRS.
To avoid the uncertainty of whether or not a gift has been made, this can be overcome by using a formal bare trust wording for the gift.
Children’s bank accounts
Saving into a child’s bank or building society account is a form of bare trust as the parent will normally open the account as trustee/nominee.
While simplicity may be the attraction here, the child is still absolutely entitled and will probably be able to access the account from age 16 to spend as they please. HMRC have confirmed that these accounts don’t need to be registered with the TRS.
Interest will be taxed on the child unless the funds are provided by a parent and the £100 rule applies, but the prospect for real returns may be limited with a recent history of low interest rates and higher inflation.
A simple alternative may be for the grandparents and parents simply to save money in their own names unless they are already maximising their own pension and ISA allowances. That’s because adults have larger tax-free allowances than children under the age of 16. This then overcomes the issue of children being able to access their own funds as early as age 16. It also saves the cost of arranging and maintaining trusts together with the additional administration and cost that comes with such instruments.
As ever the choice is yours of course.
There may be several motives for parents and grandparents to save towards their children’s/grandchildren’s futures, such as paying for education fees or helping to buy a house.
Or it may simply be a way of reducing their estate by passing on their wealth to future generations.
Whatever it is, do make sure to get professional advice from an expert. You know it makes sense.*
*The value of investments can fall as well as rise. You may not get back what you invest. The information contained within this article is for guidance only and does not constitute advice, which should be sought before taking any action or inaction. The above taxation information is based on our current understanding of taxation legislation and regulations. Any levels and bases of, and reliefs from, taxation are subject to change. This blog is based on my own observations and opinions. The Financial Conduct Authority does not regulate taxation advice, estate planning, inheritance tax planning, cashflow modelling, wills or trusts.