Children’s personal tax and other allowances, such as the annual Junior ISA and Stakeholder Pension contribution allowance, and the annual Capital Gains Tax exemption, make possible some very beneficial long-term planning opportunities. Using them wisely can set a child firmly on the road to a secure financial future when they become adults and all the way to their eventual retirement.
In England, Wales and Northern Ireland, a child is a minor until they attain 18 years of age and until then they cannot make an investment in their own name. Investments therefore normally need to be made and operated by an adult as a donor, nominee, or trustee, on the child’s behalf. Special rules apply to investments made for the benefit, or on behalf, of minor children. Whose money is being invested – whether it’s the child’s parent’s money or their grandparent’s money for example – is an important consideration when it comes to taxation. Unless the funds are gifted by a parent, a child is treated the same as an adult for tax purposes. This means they have their own personal annual allowance, savings and dividend allowances, basic and higher rate tax bands and annual CGT exemptions. Under the parental settlement rule, income resulting from an investment where a parent gifted the money is assessed on the parent if it exceeds £100 in a tax year. The point of this rule is to prevent parents ‘parking’ money in in the names of their children to benefit from tax-free interest by using the child’s annual income tax allowance. Where money is the child’s own and is not held for them in a trust or Junior ISA for example, a number of options are available, the most obvious being bank and building society accounts. These are fine for relatively small sums being saved short term, pocket money accumulated towards the purchase of a guitar for a budding future Eric Clapton perhaps, but for larger sums and the longer term you are doing a child beneficiary a disservice if you do not at least consider an investment in stocks-and-shares.
Junior ISAs (JISAs) are available for any child under 18 years of age who is UK resident and who does not hold a child trust fund account. They permit the investment of up to £9000 per child for 2020/21 by any one or more persons for tax-free accumulation of income and capital until age 18 when it will convert to an ordinary Isa. A JISA must be opened by the child’s parent or guardian but once opened anyone can pay into it, e.g., parents and grandparents, friends and relatives. In a Junior ISA, like an adult ISA all investment returns are free of any personal liability to income tax and capital gains tax. The investment returns do not count towards the child’s own personal income tax allowance or their personal capital gains tax allowance, leaving those allowances free for other investments or any earnings or income the child receives from, for example, savings account interest. A JISA will automatically roll over into an adult ISA at age eighteen, allowing the child to take a tax-free pot of money into adulthood.
Contributions to a Junior ISA do not affect the child’s own allowance to do their own cash ISA at ages sixteen and seventeen. No tax is payable by anyone contributing to a Junior ISA. Very importantly that includes parents, because of the parental settlements rule which provides that: ‘where parental gifts to an unmarried child produce more than £100 worth of income a year, then the whole of that income is taxable on the parent that made the gift’. In the past this has presented quite some difficulty sometimes when parents wish to give money to their own children, because if it produces anything other than a relatively minimal amount of income year on year, it is the parent and not the child that will be taxed. The anti-avoidance provision does not apply to a Junior ISA. Another advantage of a JISA is that the plan manager can obtain gross interest distributions from corporate bond and similar funds. Previously, even notwithstanding that the children were non-taxpayers, the interest distributions could only be paid net and the parent had to recover the tax deducted at source from the Inland Revenue. JISAs solve that and save a lot of work.
Grandparents may contribute to a Junior ISA as part of their inheritance tax planning. Everyone has an annual IHT exemption of £3000 pa on which no inheritance tax is payable. If the contributions exceed that annual exemption amount then they’re likely to be Potentially Exempt Transfers – PETS. Some of the small gift allowances or even the ‘normal expenditure out of normal income’ allowance may also be used.
Junior ISAs do come with a few strings attached. Except for on death or terminal illness, no withdrawals can be made at all until age eighteen and the child does have automatic access to the money at age eighteen. Overall though the combination of tax benefits and simplicity makes the JISA a useful tool in our tax planning workshop.
Another West Riding Exclusive
As a special concession, we make no initial charge whatsoever for setting up JISAs for the children, grandchildren or other minor family member of our existing investment clients. Our only charge is the 0.75%pa adviser ongoing fee charged to the fund to cover ongoing advice and services such as fund switching and re-platforming if those services are required. As with all investments made under our Clear and FAIR offering, our FairFees Promise also applies just the same to children’s investments, with no other adviser charges for fund switches, product transfers or reinvestments.
Stakeholder Pensions for Children
Anyone can contribute to a Stakeholder Pension for a child. The big issue to bear in mind here is that the funds cannot be accessed until the beneficiary attains the minimum age for accessing personal pension funds, which in the UK is to rise to 57 in 2028, reflecting trends in longevity and encouraging individuals to remain in work and to help ensure pension savings provide for later life. The maximum that can be contributed for a child with no pensionable earnings of their own is £2,880 per annum to which tax relief of £720 is immediately added, making a total investment of £3,600. That’s the same as achieving 25% immediate growth.
Trust Planning for Children
Where significant sums are to be invested long-term for children the investment will usually be held within a formal trust. Various types of trust are recognised in law and can be used to hold non-income producing assets such as life assurance investment bonds and also collective funds, e.g., Unit trusts/OEICs and Investment trusts.
Bare trusts entitle the beneficiary to automatically take control of the trust assets personally and completely at age 18 (16 in Scotland). Using a bare trust enables the use of the child’s own personal CGT annual exemption, which can be useful where the trust property is in the form of shares quoted on the stock exchange, OEIC shares or units of a unit trust.
Discretionary trusts give trustees control over who gets what and when along with a large measure of flexibility to change or add beneficiaries if circumstances change, albeit at a ‘tax price’. The use of discretionary trusts therefore needs to be carefully considered carefully in the context of a donor’s overall Inheritance Tax planning. Income tax and Capital Gains Tax (CGT) can be a problem in terms of both their cost to the trust fund and its time-cost to them in filing annual trustee tax returns, assuming the trustees file their own returns. If they have an accountant file for them then there will also be a monetary cost.
Income Tax and CGT liabilities can often be circumvented by using a life assurance investment bond which in law is a non-income producing asset, meaning there won’t be anything to report unless a chargeable event occurs. Again, careful planning is essential and Trustees should never take action without consulting their financial advisor.