How to minimise tax on children’s investments
Interestingly there are a number of tax efficient and simple ways in which you can invest money for children and grandchildren in the UK today.
Junior ISAs and Adult ISAs
Junior ISAs are available for children up to age 17. Such ISAs have to be set up by parents. They are totally free of Income Tax and Capital Gains Tax. The maximum permitted investment is currently £4128 p.a. A child cannot have one if he or she has a Child Trust Fund though such a Fund can be transferred into a Junior ISA. Interestingly once the child reaches the age of 16 he/she may invest up to £20,000 each tax year into an Adult ISA too! The downside is that the money is the child’s at age 18.
A Junior SIPP is a Self-Invested Personal Pension which may be set up and managed by a parent or legal Guardian up until the child reaches the age of 18. Again it is free of Income Tax and Capital Gains Tax as well as Inheritance Tax so it is in fact totally tax free. Again it becomes the child’s money at age 18 but the money cannot be accessed until the child attains the age of 57. The maximum permitted annual investment is £3,600 gross (£2,880 net of tax relief). The government will pay in up to £720 a year in the form of tax relief even though your child is probably not a taxpayer. That means you only invest £2,880.
If you were to pay £300 gross (£240 net) a month into a Junior SIPP from the date your child was born it could grow to nearly £600K by your child’s age 65. If your child were to continue to pay the same amount of money monthly the entire pot could reach nearly £1 million by their age 65. This is based on an assumed investment return of 5% p.a. and charges of 1% p.a.
An alternative is to invest money into a taxable investment by using an arrangement called a bare trust. This could be used for example if the Junior ISA and Junior SIPP limits have already been fully utilised.
The advantage of this sort of arrangement is that the child’s own personal tax allowances of £17,500 a year (personal allowance £11,500, dividend allowance £5,000 and savings allowance £1,000) can be utilised meaning that most if not all income and capital gains remain tax free.
However, if the investment is provided by a parent/s then any income generated of more than £100 per parent per tax year is taxed at the respective parents’ highest rates of Income Tax. Interestingly any capital gains from the child’s investments are not taxed on the parent/s.
If a grandparent or other relative or family friend invests the money in the name of the child there is no Income Tax for the donor to pay on any investment income generated.
Monies paid into any such investments or pensions by donors such as parents and grandparents will only escape Inheritance Tax (IHT) if the donor uses the available IHT exemptions such as the annual exemption of £3K per person and the small gifts exemption of £250.
Gifts out of income are also free of IHT but they have to be gifts that do not affect the standard of living of the donor and may have to be proven at a later date to HMRC. So good records are recommended. A lifetime cashflow forecast such as the one we use for all of our clients would be invaluable as proof of affordability.
If you survive 7 years after making the gifts no IHT will be payable anyway as such gifts are known as Potentially Exempt Transfers or PETS.
So if you are a parent or a grandparent with children or grandchildren under the age of 18 why not contact us for a review of your investments, your child gifting strategy and your Inheritance Tax position? You know it makes sense.