Faced with some considerable headwinds – rising house prices, rising rental costs, insecure career prospects, university fees and end of defined- benefit pensions – most parents and family members see the merit in saving for their children from as early as possible.
This will help parents plan for their children's future, creating a nest egg for them, helping to support them financially when they reach a certain age - whether it helps them to buy their first car, used towards a deposit for a house or even reinvested to help them maintain this financial buffer.
Here are some ways of enabling this:
Junior ISAs (JISA)
The current annual savings limit for JISAs is £4,128 , rising to £4,260 in the 2018/2019 tax year. Anyone can contribute, up to this limit, during the year. Within the JISA, you are able to split your funds between cash and investments. The allocation depends on the risk profile of the account holder and family but given the longer time horizon of JISAs, most younger savers could potentially afford to add some risk to their portfolio. Income and capital gains are tax free. The power of compounding and regular contributions can lead to healthy balance at the end of the term.
When the child turns 16, they can manage the accounts, and withdrawals are allowed at 18. From 16, the account holder is also able to set up another standard ISA alongside their JISA.
When the holder turns 18, the funds are legally theirs to do what they please. However, funds allocated for university costs or house deposits could be spent on the “wrong” things so beware.
JISAs replaced Child Trust Funds (CTF) in 2011. Child Trust Funds were opened for all children born between 1st September 2002 and 2nd January 2011 and credited with £500 from the Government. CTFs are still valid accounts and £4,128 can still be added tax free per year to these accounts. However, innovation and competition in this market has dwindled and more competitive rates can often be found in the JISA market. You can trace CTF accounts using this government site. Check the rates and see whether it makes sense to transfer into a JISA but beware of transfer charges, particularly if your Child Trust Fund is holding equity or fund positions.
Defined Benefit pensions (and who knows, the state pension as we know it) will likely be an alien concept to our children as they reach adulthood. Helping your children develop their pension nest egg from a young age can harness the power of compounding to a further degree.
There is a £3,600 annual allowance for contributions to Junior SIPPs. The Government pays 20% tax relief on contributions and some gifts into a Junior SIPP may also qualify for IHT exemptions. Investments held in the Junior SIPP are free from income and capital gains taxes.
The junior-party can access the account from 55 (57 from 2028), as with standard pension freedoms.
The portfolio will need to be allocated according to risk appetite and monitored but given the 40/50-year timeline, some risk could be added to this portfolio. Beware of annual account charges and, as with all accounts, consider the use of Open-Banking-enabled aggregator tools which allow you to monitor all of your accounts on one platform.
Bare Trusts are often used by grandparents looking to donate assets to their grandchildren for things such as university costs.
The amount paid in could fall outside the donor’s estate for IHT purposes (subject to the potentially-exempt-transfers rules).
Within the trust, income and capital gains are taxed at the child’s marginal tax rates after all the child’s allowances have been used up.
The funds are allocated to the child aged 18 but can be accessed early for certain “life” events such as education costs and emergency healthcare. There is a legal cost to setting up the trust.
Traditional high-street bank options:
When it comes to income tax, children are actually taxed the same as adults but obviously, in the majority of cases, they have no earned income.
The introduction of the Personal Savings Allowance in 2016 which means basic rate taxpayers can earn £1,000 of annual savings interest tax-free so the attraction of JISAs has dimmed for modest, cash savers.
During 2017-18, adults and children will only pay tax if their income exceeds £17,500 – this is made up of the £11,500 standard personal allowance, £5,000 starting rate for savings and the £1,000 personal savings allowance.
However, beware the “£100-rule” which can arise. If you child receives more than £100 in interest from money given by a parent then the parent has to pay tax on all this interest if they have already used their own Personal Savings Allowance. The £100 limit does not apply to money given by grandparents, friends or relatives or to JISA/CTF accounts.
Previously, parents had to fill out an R85 to prevent tax being withheld at source on children’s’ interest income but that is no longer required.
Child accounts offer teaser rates, which often assume a regular deposit and some withdrawal restrictions. Chasing the best rates may involve regular switching and parents may need to have an account with the bank but the major banks are competing for long-term custom so try and make that competition work for your children.
Including your children in this process is to be encouraged too. It can teach them the benefits (and necessity) of long-term saving and how banks compete for your account, helping them take the first steps along their financial education journey.