A Junior ISA may be the default choice when investing for children, but it is not the only option. Shoaib Ahmed, Senior Technical Manager at M&G, explores the trade-off between tax efficiency and control, and examines the alternatives available to parents who are concerned about handing over a potentially significant sum at age 18.
When investing for children, parents typically resort to using a Junior ISA (JISA) as it is easy to understand, tax-free and offers simple administration.
However, for some clients, and particularly those who are making sizeable contributions into a JISA every tax year, there is an inherent risk. The child will become automatically entitled to the funds at age 18 and this may not be aligned with the family’s objective.
For example, if a parent was to fully utilise their child’s JISA allowance from birth to age 18, then they would be making contributions of £162,000 (£9,000 x 18). When you then factor in potential investment growth, the value of the JISA for an 18-year-old is very likely to exceed £200,000.
Most parents would acknowledge that the prospect of an 18-year-old receiving a £200,000 lump sum at 18 is not ideal. So, if this is the case, then why do they still opt for the JISA?
Whilst the JISA is the default choice for investing for children, some parents may not be aware of alternative wrappers that offer greater control over when children receive the funds.
What are the alternatives?
A Junior Self-Invested Personal Pension (SIPP) would solve the problem of access at 18, as the earliest a pension can be accessed is currently 55, and this will be rising to 57 in 2028.
In addition to this, if parents contribute the maximum of £2,880 (per tax year), then HMRC will top-up the pension by £720.
However, it would be fair to say that a Junior SIPP is not a substitute to a Junior ISA, as it fulfils a vastly different objective (e.g. funding retirement). When parents save into a Junior ISA, the intention will probably be for pre 57 use such as university, helping their children onto the property ladder or perhaps cover the cost of a wedding.
These objectives cannot be achieved with a Junior SIPP, so it can be ruled out as an alternative to a Junior ISA. Albeit, setting a Junior SIPP up to give children a head start on retirement could still be a very good idea, especially with the tax-relief on offer, and the power of long-term investing.
A General Investment Account (GIA) held in the name of the parents could work. The account would be in their name, and the money could remain invested until a point in time in which the child would require the funds.
Although this might solve the issue of children having control at 18, it might be inefficient for tax purposes. Because the account would be in the name of the parents, they would be liable to any tax, and if the parents are higher or additional rate taxpayers, then any dividends could attract tax at 35.75% or 39.35%.
In addition to dividend tax, you would also have capital gains tax at 18% or 24% to pay when realising gains in the future. Additionally, the GIA would also still form part of the estate for IHT purposes.
So, in short, a GIA may work from a practical perspective of retaining control, but it would not be as tax efficient as a JISA, and it would create ongoing tax reporting requirements.
As an alternative to a GIA, parents could open an Onshore Bond and use this as a vehicle to save on their children’s behalf. And they could potentially assign bond segments to children in the future when they are ready to release control.
Now in theory, an Onshore Bond would stop the dividend rates of tax being incurred, but you are still paying internal tax in the fund, which does create a tax drag on investment returns. The rate of internal tax could be 20% (22% from April 2027), albeit the actual rate is likely to be lower because dividends are exempt from tax in an onshore bond.
Therefore, with an onshore bond, you are not achieving the same level of tax-efficiency as the JISA, as there is no internal tax in a JISA.
And if parents were prepared to assign segments to children at 18 and the children were non-taxpayers at this point in time (e.g. education), you would not be able to reclaim the internal tax that had already been incurred inside the onshore bond.
So, in summary, an onshore bond is perhaps similar to a GIA. It might solve the problem of control, but the tax efficiency is significantly less attractive than a JISA.
Is an Offshore Bond the answer?
From a tax perspective, an Offshore Bond is much closer to a JISA than an Onshore Bond or GIA.
This is because within an Offshore Bond, there is gross roll-up meaning there is no tax on income and gains within the fund. This is similar to the tax treatment of a JISA.
Of course, with an Offshore Bond, the tax is deferred to exit, whilst with a JISA, there is no tax whatsoever.
But with the right planning, there can be ways of extracting funds out of an Offshore Bond without paying any tax. This will depend on the child’s future tax position and the size of any chargeable gains.
As a reminder, a non-taxpayer can realise up to £18,570 of chargeable gains every tax year and pay no tax whatsoever. Therefore, could parents potentially consider assigning segments to their children when they turn 18, and if those children are in education, there could be a period of 3, 4 or 5 tax years where bond gains could be surrendered, and no tax would be paid.
Crucially though, the parents would be under no obligation to assign segments to their children once they turn 18. This is the biggest advantage an Offshore Bond has over a JISA, control of when parents want their children to have access to the funds.
Parents could choose to retain the Offshore Bond in their name and wait for the children to turn 25, or even 30.
Another advantage that Offshore Bonds have over a Junior ISA is that grandparents can open them. A JISA can only be opened by a parent or legal guardian, which does act as a barrier for grandparents wanting to save for grandchildren.
The Offshore Bond can also be used in conjunction with a discretionary trust, which means it is useful for grandparents wanting to start their own inheritance tax planning.
Concluding thoughts
A JISA is a tax wrapper that offers ultimate tax-efficiency, but parents should be aware that this tax-efficiency does come at a cost, and that cost is a lack of control.
An Offshore Bond may not fully replicate the tax-free treatment of a JISA, but it can provide a combination of tax-efficient growth, flexibility, and control that some parents might find more appealing.
Choosing the right tax wrapper will very much depend on the views of parents and whether they feel comfortable with their children having access to large lump sums at 18.
Main image: Children, ben-wicks-iDCtsz-INHI-unsplash
