BLOG: Four ways to make a financial Christmas gift for children
You may want to provide them with some financial assistance at a later date to assist with University fees, or in buying their first home, or encouraging them to save towards their retirement even.
A gift in this regard could help to get them engaged in their finances and teach them the benefits of long-term investing. So what options are available in this regard?
1) Bank account basics
Probably the most common method of saving for a child/grandchild’s future is to open and/or contribute to a bank account in their name.
The bank of England base rate currently stands at 3.5% and while on the face of it these products provide monetary security (£1 saved today will still be worth £1 when it is withdrawn, plus hopefully a little bit more by way of interest), deposit savings have, historically, failed to keep pace with inflation.
This means their ‘purchasing power’ is eroded over time (£10,000 today would purchase you less than it would have 20 years ago). With inflation also running at double-digits (10.7% in November), it is unlikely that a deposit account would provide any ‘real returns’ for your child/grandchild (i.e. returns in excess of inflation) over the long-term.
It is also worth highlighting that if the child achieves over £100 of interest in a given tax year on monies gifted to them by their parents, this interest is taxable against the parents’ marginal rate . A possible alternative to avoid this drawback is to use a Junior ISA (JISA).
2) JISAs – keep in cash or invest?
Similar to adult ISAs, there are two types of JISAs; a Cash JISA and a Stocks & Shares JISA. They can only be opened by those who have parental responsibility, however anyone can contribute to a JISA on behalf of the child, including their grandparents, but the maximum of all contributions is limited to £9,000 p.a. (2022/23 tax year).
As with an adult ISA, the interest/investment returns achieved on a JISA are done so tax-free, and withdrawals (when they are eventually made) are done so free of any income or capital gains tax liability, and zero reporting requirements.
While a Cash JISA provides the same monetary security as a deposit savings account, it also carries the same inflationary risk over the long-term. A Stocks & Shares JISA has the potential to counter this by allowing your gift to be invested in global or local stock markets.
Historically, equities have outpaced inflation over the long-term, and they provide investors with ‘real returns’ (i.e. returns in excess of inflation). There are however some very real short-term risks to equity investments, and the potential that you could get back less than what was invested.
Both Cash and Stocks & Shares JISAs can be opened at any age and become the child’s to manage at age 16, and theirs to use as they see fit from age 18. If the child is young and has 10+ year before they attain age 18, then it might be best to consider the Stocks & Shares option. If however the child is aged 13 or over, then a Cash JISA might be better as it avoids any short-term risks associated with equity investing.
The fact that JISAs provide full and unrestricted access to the child at age 18 is often a sticking point for a number of parents who want to retain an element of control as to how the gift is accessed, and when.
An alternative that I often suggest to my clients is to establish a separate standalone investment account in their own name but held in ‘designation’ for the child. Depending on the provider of the separate standalone investment account, the investments that are made may have differing legal consequences for the adult who opened the account and the child who it is intended for including the potential application of inheritance tax.
It is very important to check and fully understand from the provider and your financial adviser what the consequences are for both the adult and the child.
Please note however that when it comes to eventually distributing the investment proceeds, any tax consequences stemming from the sale of the investment fall upon the adult owner, so make sure you manage this correctly, including the requirement of registering the account on the Trustee Register where suitable.
3) Trusts & tax
Designated accounts are great for regular contributions (every Christmas and/or birthday for example), but for lump sum gifts Trusts are another option where you get to retain an element of control.
Monies placed into Trust can be held and distributed at the discretion of the Trustees (of which the person making the gift, often referred to as the ‘Settlor’, can be included). This ensures that the funds are only distributed at the intended time. Another feature of gifts made to Trust is that the proceeds have the potential to escape the ‘Settlor’s’ Estate for Inheritance Tax after seven complete years of the gift being made, which may be advantageous to some parents/grandparents depending on their circumstances.
4) Pensions – never too early!
The final option available to parents is to establish a pension on behalf of their child using the gifted proceeds.
Pensions can be established for a child of any age by the parents but once it is in force, anyone can make contributions towards this arrangement. Contributions made receive basic rate tax relief at source, so a £100 contribution becomes a gross pension investment of £125.
There are however restrictions on the amount that can be contributed on the child’s behalf while they are not working, and this is £2,880 net per annum (£3,600 after basic rate tax relief has been added).
In terms of access, pensions are certainly the most restrictive. Under current legislation the earliest that an individual is able to access their pension is age 55 but the intention is to push this back to 10 years prior to State Pension age.
I often say to clients that the earlier a person invests in a pension, the better. And its restrictive access means the child gets to fully understand and explore the benefits of holdings a long-term investment, without fear of it being squandered at an early age.
Tim Stubbins is chartered financial planner at One Four Nine Group