Three alternatives to Junior ISAs for children’s savings
A regular concern for parents is the question of how to save for children. While the simplest option may be to open a bank account or enter into an investment arrangement for them, the tax rules do not favour parents saving for their children.
Where minor children are given funds by a parent and the income from those funds exceeds £100, the parent is liable to the income tax. While this rule does not apply to other family members, in most situations the only other family members willing to make gifts to children are grandparents.
Child Trust Funds (CTFs) were one of the first government-approved savings routes for minor children which did allow parents to make gifts. They were made available to children born between 1 September 2002 and 2 January 2011, with an initial minimum £250 payment from the Government into the scheme with an intended further payment at age 7 of the same amount. Parents could add additional amounts each year and the fund benefited from a tax free status on the income and gains generated.
However, as investment provider charges were limited and the amounts invested tended to be small, particularly as many parents were concerned that the accounts became the children’s at age 18, not many providers entered the market.
In November 2011 Child Trust Funds were replaced by Junior ISAs which gave parents access to the normal ISA market, although the amount which can be invested is around a third of that for adult ISAs. It looks as though the Government will be permitting the transfer of Child Trust Funds to Junior ISAs from April 2015.
Alternatives to Junior ISAs
Alternative ways to keep funds under parental or others’ control, while avoiding the rules which tax income on parents, include using a trust (again settled by grandparents or other family members), company or pension scheme.
While it is no longer possible to create accumulation and maintenance trusts, following a change in the tax rules in 2006, discretionary trusts remain an option, typically for grandparents to make gifts to grandchildren.
While the tax rate within such trusts remains high, where income is paid out the children will be able to reclaim the tax paid if the income they receive is within their personal allowance. The process of trustees paying the tax and the children making a reclaim could be avoided by granting the child a life interest for a period of time. This would mean that all of the income generated within the trust must be paid out to the child annually without the choice of timing payments appropriately.
If parents are happy to roll up funds under parental control until children are over the age of 18, a trust could be settled by parents and payments made out of the trust once the children are 18 and have, for example, started university, and the parents would not be liable to tax on the income.
Income tax will have been paid by the trustees over the years on the income, but this should be repayable as distributions are made by the trust depending on the children’s other income. The tax borne by the trust could also be mitigated in part by having high growth assets, with low income yields where possible.
Personal investment companies
Personal investment companies (PICs) provide the control and flexibility of investments held by a trust but allow parents to pool assets with children and may therefore give better returns as investments could be much broader. For example, this might include property as well as portfolio investments. Through differing share classes the parents and children could be given different capital value and income from the company, as controlled by the directors of the company, typically the parents. PICs could also be used as a mechanism for flexible, longer term, inheritance tax planning.
Stakeholder pension savings provide even longer term savings for children and allow parents to make contributions on behalf of children into a pension scheme. While the savings are, of course, for the very long term, the tax relief does mean that HMRC adds 20% to the amounts contributed to the pension fund each year, which would then grow tax free.
There are many options available for saving for children; which one is the most appropriate will depend on where the funds are coming from and when they are likely to be needed. It’s worth exploring the options.
Gary Heynes is head of private client at Baker Tilly