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TDQ: Investing for Children

18 May 2020

It’s important to be prepared for a question on the subject of investing for children, says Catriona Standingford, MD of Brand Financial Training, as questions can arise in R02, R03 and R04 and could also be included in case studies in R06.

This article was first published in the May 2020 issue of Professional Paraplanner.

Investing for young children makes sense where parents or grandparents are in a position to do so. After all it’s not long before young people get to age 18 and face costs such as university fees, rent and eventually wanting to climb onto the property ladder.

Obvious starting point

There are various products to choose from with the obvious starting point the Junior ISA; these work like adult ISAs in that income and capital gains are tax free. Children don’t usually pay tax anyway so the main advantage really is for the parents making maximum use of the annual subscription – if this was held in an ordinary savings account any interest would be taxed back on the parent if it was over £100. With a Junior ISA the parental income tax rule doesn’t apply.

For a stocks and shares Junior ISA there’s no CGT on gains and the investments grow tax free. Investing in equites while the child is young makes sense as the timeframe should be long enough to ride out any short-term volatility.

The annual amount which may be contributed is of course lower than a normal ISA; but one surprise in the budget was the new Chancellor increasing the amount which can be invested by over double, from £4,368 to £9,000 for the 2020/21 tax year.

At 18 the investment belongs to the child (which means they can do what they like with it). Because of this it may be a more sensible option to invest through a parent’s ISA, so they have more control. Remember too that a Junior ISA can be held as well as an adult ISA between the ages of 16 and 18.

Other tax-efficient savings

Another tax-efficient savings option are endowment policies for children bought from Friendly Societies. These 10-year savings plans are also tax free so legislation imposes a maximum amount that can be invested; this is £270 per year or £300 per year if £25 is paid in each month.

A popular investment with grandparents for their grandchildren is National Savings & Investment Premium Bonds. The minimum investment is just £25 so they make ideal gifts. If the child is under age 16, the parent or guardian nominated on the application looks after the premium bonds regardless of who actually buys them. The odds of winning for each £1 bond number from May 2020 is 26,000 to 1, so the more you have the better the chances of winning.

Pensions

For some parents, investing in a pension might be an option for their child. Parents and legal guardians can set up a pension which will automatically transfer to the child when they reach age 18. At that point they can start to save themselves. The maximum amount that can go in is £3,600 a year so the contribution from the parent could be up to £2,880 a year. With the tax relief available this grosses up to the maximum of £3,600. Imagine how much could be in the pot when the child eventually reaches retirement age!

Using trusts

Bare Trusts can also offer a convenient way to invest money for a child’s future. They are also known as absolute trusts meaning that the beneficiary cannot be changed and has an absolute right to the trust assets.

A bare trust is a simple arrangement; assets are simply held by a trustee for the benefit of the beneficiary. At age 18 the property can be passed to the child; this is important as the trustees have no discretion over whether or not they should receive the trust property.

There are taxation benefits of using a bare trust:

  • the income is taxable as the beneficiary’s income and at rates that depend on the beneficiary’s other income
  • the beneficiary rather than the trustee is liable for the tax and must declare income annually through self-assessment
  • they can use their personal allowance, the starting rate band, the personal savings allowance and the dividend allowance

If the capital came from the parent however and the income exceeds £100 gross in a tax year this will be taxed back on the parent as their income. This only applies to income and any capital gains will always be taxed on the child (and they can use their full annual exempt amount). Income of below £100 is treated as the child’s for tax purposes. This rule does not apply to gifts from grandparents or other relatives.

A bare trust could be used to provide income to pay a grandchild’s school fees – the gift into the trust is a potentially exempt transfer (PET) for IHT purposes so as long as the settlor survives seven years it will be outside of their estate. The trust assets are not ‘relevant property’ so there are no ten yearly charges.

If a grandparent has an inheritance tax liability they wish to address, they can make gifts to reduce the tax bill. The annual allowance is £3,000 per year and the small gifts exemption is £250 so these amounts can be given to grandchildren without any immediate inheritance tax consequences and will reduce their estate.

Regular gifts out of income are also exempt as long as they don’t affect the giver’s normal standard of living, are regular and are from true income and not capital. It’s a good idea to keep a record of these gifts and the proof that it is normal expenditure out of income as HMRC will want to see this when the person claiming the exemption dies.

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