Several financial products enable parents and carers to invest tax efficiently for children. In this blog Acumen explores the full range of tax efficient investment opportunities available today.
As parents we all want the best for our children. Making wise investments on their behalf, to secure their futures is a crucial, yet complex, area of consideration. Tax is not the only factor to take into account. Apart from investment risk and reward, there is the small matter of the costs of investing.
Some investments can be significantly more costly to buy and hold than others. Here, we explore some of the most common investment options for children and give the pros and cons for each.
The Junior ISA, or JISA, is like the adult ISA, that protects the investments and savings held within it from income and capital gains tax. It now allows up to £4,000 (£4,080 in 2015/16) to be invested on behalf of a child in cash and/or a wide variety of stock market-based investments.
Children who are 16 or 17 can also invest in a full ISA but only in the cash component. The contribution ceiling for this component is £15,000 in 2014/15, rising to £15,240 in 2015/16.
Child trust funds
Child trust funds (CTFs) are very similar to JISAs and were set up for children born between 1 September 2002 and 2 January 2011. Every child born between those dates has a CTF to which parents and others can contribute £4,000 in total (£4,080 in 2015/16). If a child is eligible for a CTF, they cannot have a JISA and the reverse is also true.
If your child’s JISA allowance has been used up for the tax year, and you still want to invest more in stocks and shares on their behalf, you could consider collective funds – unit trusts, investment trusts or OEICs. Investments in funds for children are usually held in a designated account, which is administered by the parents, and belongs to the child. They cannot normally access the funds until they are 18.
This facility can allow parents to invest for a child without the income being subject to tax at parental rates. Then when the child reaches the age of 18, the investment can be sold and set against the child’s personal allowance. This would allow them to receive (in 2014/15 terms) up to £10,000 free of income tax or up to a further £31,865 to be subject to just 20 per cent tax (£10,600 and £31,785 in 2015/16 terms).
Life assurance investment bonds
These investments can also be used to postpone the potential tax liability on investments until a convenient time for their encashment. Parents or others can invest in these bonds for the child – usually within a trust for the child. The investment bond produces no income for the trust itself and the funds within the bond are subject to tax at the life insurance company’s rates. When the child reaches the age of 18, or some time later, the trustees can pass over the bond to the child who can encash it at the rates that apply to them that year.
The generous tax breaks and long investment term make pensions an effective way to invest for children. Anyone can contribute, up to an aggregate of £3,600 gross in a tax year, into a personal pension for a child. Contributions automatically benefit from basic rate tax relief, so this means only £2,880 is paid into the scheme and the government will make up the balance. Returns roll up broadly UK tax free within the fund and ultimately up to 25 per cent of the pension fund can be taken as a tax free lump sum with the rest of the fund drawn as taxable payments.
Friendly society bonds
Some friendly societies offer tax free savings schemes for children which can be specifically designed to mature for a significant event, like an 18th or 21st birthday, or starting university or graduation. The maximum investment is £25 a month, or £270 a year, and bonds must last for at least ten years for the proceeds to be free of income and capital gains tax. Although the premiums on these schemes are low, the charges can be high.
National Savings and Investments Children’s Bonds
Parents, guardians, grandparents and great grandparents can invest from £25 to £3,000 in total for a child under the age of 16 in each issue of Children’s Bonds. The bonds pay a fixed rate of interest – the current issue pays 2.5 per cent. Returns are free of income and capital gains tax, but the bond must be kept for the whole five year term as if it is cashed in early, a penalty equivalent to 90 days’ interest applies.