Saving for children is a fantastic way to give them a head start in their adult lives…
With the cost of university fees and purchasing your first home on the rise, parents and grandparents can help craft a strong foundation through regular saving and investing.
Regularly putting aside small amounts could make a real difference for a child and this blog will help you decide on the options available by delving into the advantages and disadvantages of each.
It is important to point out that children have their own personal allowances. This means a child will only pay tax if their income exceeds £18,500 in the 2020/21 tax year. This is made up of the personal allowance (£12,500), starting rate for savings (£5,000) and the personal savings allowance (£1,000).
However, any income exceeding £100 gross in a tax year which has derived from a gift from a parent is taxed as that parent’s income if the child is under the age of 18 and unmarried / not in a civil partnership.
This rule is applied to the majority of children’s savings accounts except JISAs (Junior Individual Savings Accounts) – which remains totally tax free in the same was as an adult ISA. Grandparents and other relatives are not affected by the ‘£100 rule’
It is also worth noting that any account held in a child’s name becomes legally theirs to do as they wish as soon as they reach 18 years old. If you think a large lump sum and an 18 year wouldn’t mix well, there are options such as a Junior Pension or even setting up a Discretionary Trust.
1. Children’s Savings Accounts
The majority of banks and building societies have a children’s saving account, which can be opened with as little as £1 for any child up to the age of 18. There are two main types of children’s savings accounts: instant access (or easy access), and regular savings.
Instant Access Accounts – With these accounts, you or your child can withdraw or deposit money at any time. These accounts tend to offer a lower rate of interest.
Regular Savings Accounts – The purpose of these accounts are to encourage children to save an amount every month over a set period of time such as 12 months. These accounts usually pay a higher rate of interest because they tend have more restrictions in place.
Advantages:
- Offer a great way to get children involved in managing money and to help start a savings habit.
- Some providers will include a gift when opening an account
- Start with a minimal amount, usually £1
- The child can manage their own money once they reach the age of seven
Disadvantages:
- Regular accounts tend to have lower savings limits in place
- Interest rates can be slashed by the provider when deposits exceed a certain limit
2. JISA – Junior ISA (Cash or Stocks & Shares)
JISAs have been around since November 2011 aimed at replacing the Child Trust Fund. JISAs have an annual savings limit of £9,000 (2020/21) which can be held fully as cash, stocks and shares or a combination of the two.
Cash ISAs can be a great saving opportunity because the child will not pay any tax earned on any interest. Stocks & Shares ISAs let you buy shares, bonds and other eligible investments which are also tax efficient because any investment returns are free from Income Tax and Capital Gain Tax.
A JISA account can only be opened by a parent or guardian, but anybody can pay into it for the benefit of the child. Once the child reaches the age of 18, the JISA automatically becomes an adult ISA and they can withdraw any amount of money as they please.
N.B. Only two JISAs can be held per child at any time. That could be one Cash JISA and one Stocks & Shares JISA. However, between the ages of 16-18, a JISA can be held alongside an Adult ISA which gives an additional tax-free allowance for two years.
Advantages:
- Very tax efficient as there is no tax liability on interest or investment returns
- As of 2020/21, the higher annual savings limit has been increased to £9,000
- Any previous Child Trust Fund savings can be transferred into a JISA
- Wide investment choices
Disadvantages:
- No tax relief on ISA contributions
- If you don’t contribute the full £9,000, you will lose any remaining allowance in the next tax year
3. NS&I Premium Bonds
Premium bonds are very different to other savings and investments, where you are entered into a monthly prize draw rather than earning interest or a dividend income. Each month, prizes can be won between £25 and £1 million tax-free. Each bond has a unique number which cost £1 each, the more you buy the more your chances improve of winning a cash prize. NS&I draw the winning numbers each month using a random number generator, known as Ernie – Electronic Random Number Indicator Equipment (one for the pub quiz!):
- Minimum Purchase: £25 for one-off and monthly standing orders
- Maximum you can hold: £50,000
- Must be over 16 to purchase Premium Bonds. However, they can be held for children in the name of a parent or guardian.
According to NS&I, the average payout or annual prize rate would currently be equivalent to an interest rate of 1.4%.
Advantages:
- All prizes are tax free – any returns will not count towards the Personal Savings Allowance (PSA)
- NS&I is Government-owned, meaning that there is no risk to your capital and is totally protected as it is backed by the Treasury
- Prizes can be withdrawn to spend or they can be reinvested allowing your savings to benefit from compounding.
Disadvantages:
- Premium Bonds come with inflation risk. During economic periods where inflation rates are higher than the annual prize rate, your savings will shrink in terms of real value.
- Premium Bonds cannot be passed on after death. The executor must cash in the bonds, which then becomes part of the deceased estate.
- Therefore capital from Premium Bonds may be liable to inheritance tax.
4. Junior Pensions
Junior Pensions are very attractive if you like the idea of planning ahead for children to help them in their older years. Parents can set up a pension for their child as soon as they are born and can start building a future retirement pot for them. An incredible benefit of Junior Pensions is that they are eligible for 20% tax relief on any contributions up to a limit of £2,880 per year. In other words, paying in £2,880 per year your child would actually receive £3,600 in total due to the added tax relief. Any growth within a child’s pension is free of tax, just like a JISA. The beauty of long-term saving, which is prevalent for pensions, is the power of the effect of compounding.
For example, let’s assume a parent sets up a Junior Pension for their new-born child and commits to saving £2,880 per year until their child reaches the age of 18. Let’s also assume an annual interest rate (or rate of return) of 5%. By the time that child reaches the age of 65, that pension would be worth £1,007,329.76! This illustrates the power of compounding over a longer time horizon, bearing in mind that the parent only paid in a total of £41,040 in those first 18 years.
However, like all pension plans, they can only be accessed at the age of 55 at the earliest.
A word from our director, Dominic, on Junior Pensions, “I love pensions. There I said it! And you know what I’m not ashamed of it!! No matter who you are, pensions are a great savings vehicle. My boys are 4 & 5 and both have pensions. Just like them, tiny miniscule little monthly saving ones, but as the saying goes from tiny acorns…! For me it’s all about compound interest, making sure the assets do not get ‘wasted’ at age 18 and to release them from financial burdens of needing to save in their 30’s and 40’s. I accept its boring for a grandparent, but for a parent it ticks all of the boxes, in my opinion!”
Advantages:
- The biggest advantage is the eligibility for tax relief, which boosts the savings pot.
- Can benefit massively from compounding due to the length of time savings must be held.
- Tax free growth
- Anybody can contribute into the pension for the child. For example, a grandparent at could pay a lump sum of up to £2,880 each tax year.
- At 18, the pension transfers to the child as an adult pension allowing them to continue to contribute
- 25% of the pension pot can be taken as a tax-free lump sum at the age of 55
- Possibility that the money built up in a pension will be used more responsibly later in life.
- Saving now actually benefits the child in their 30s and 40s, as a pension provision is not left until later life to arrange (a favourite of our director this one)
Disadvantages:
- The most obvious disadvantage is the fact the pension fund can only be accessed at age 55
- As with any investment product, the value can go up as well as down.
5. Friendly Society Tax-Exempt Plan
Friendly Societies are what is known as ‘mutual benefit organisations’. This means they are owned by their members to work towards the advantage of the members. These plans typically have a payment period of between 10 and 25 years. The maximum you can pay into these is £270 a year, or £300 a year if you pay monthly instalments of £25. This money is then invested into a share-based investment fund, which again is subject to investment performance. The child must be at least 16 years old and the plan must be held for a minimum of 10 years in order to remain exempt from Capital Gain Tax and Income Tax.
Advantages:
- Affordable way of saving towards your child’s future
- Exempt from tax as long as the plan is held for 10 years
- It’s an additional tax-free allowance on top of your annual ISA allowance.
- Tend to come with membership benefits such as grants towards higher education
Disadvantages:
- Not keeping up with payments may result in the plan lapsing with a surrender penalty or even no value at all.
- Withdrawals are not allowed until the plan reaches it maturity date
- Often a limited investment choice
6. Trusts
Trusts are great for passing assets to children or grandchildren, but they are highly complex and require professional advice if this is something you are keen to explore. A trust is a legal obligation where one or more ‘Trustees’ are made legally responsible for controlling assets for the benefit of the ‘Beneficiaries’ (in this case, your child or children). A variety of assets such as land, investments, property and even antiques can be placed in trust by a “settlor” for the beneficiaries. It is the trustees’ legal responsibility to manage the trust assets acting in the settlor’s wishes.
As a very simple overview, there are two types of trusts, which are Bare Trusts & Discretionary Trusts:
Bare Trusts – These give the children an absolute right to access the money at the age of 18
Discretionary Trusts – These allow the trustees to decide when and how much to pay out to the children in accordance with the settlor’s wishes.
Our co-director, James Thompson, explains, “When looking at the planning options available for children, trusts can give that element of control that many of the options don’t. Parents can start to create sizeable long term savings for their children which is also a benefit that many other plans can’t accommodate, most are limited to a few thousand pounds a year whereby trusts can move into the hundreds of thousands and provide additional inheritance tax breaks.
Nevertheless with the complexity involved I would always strongly recommend that trust-based planning is undertaken as a collaborative project together with an individual’s tax and legal advisers, to ensure that all angles are fully considered.”
Advantages:
- Trusts are a great tool for tax planning, especially in relation to inheritance tax and estate planning
- Provide a means to preserving family assets for later generations
- Trusts can support those who are most vulnerable and who may have difficulty managing their own money. For example, trustees can help someone with a mental health condition or disability who may be unable to manage their own financial affairs
- Trusts can provide continued control for parents who may be unsure at what age a child should receive access – they can be very flexible in this regard
Disadvantages:
- Complex and require professional advice, which can be expensive
- Years of trust planning could be damaged with any changes to the current legislation, caveating their intended purposes.
We hope this extended blog has helped you understand the options available to you when considering the savings options for children. Overall, building up savings for a child is very achievable, given the variety of solutions available to suit all budgets. Having clarity on how you want these savings to be used, your child’s control over it, and at what age you would want your child to access it, are all key considerations before choosing the right solution for you. Combining these vehicles with a high quality and well managed investment solution will be key to the success of any savings approach. Added to that the effect of compounding, there is no time soon enough to start saving and giving your investment as long as possible to accumulate in value.
Please feel free to get in touch with Becketts should you wish to know more about any of these products or you would like us to help you get started.
