Investing for Children

With effect from 6 April 2018, the Junior ISA allowance has increased to £4,260.  In this article we look at JISAs and other options for doctors who are saving and investing on behalf of children aged under 18.

Junior ISAs

ISAs are popular amongst adult investors so we inevitably get asked about the junior version by doctors looking to invest money for their children or grandchildren.  The key points to bear in mind about the Junior ISA (JISA) are that the money cannot be accessed until the child is 18, and that once they are 18 the child (now an adult) is legally entitled to access the money and use it how they wish.  Depending on the intentions for the money, this might exclude the JISA option, for example if access may be needed for the child’s benefit before age 18, perhaps for education related costs e.g. school fees, school trips, sports equipment, a musical instrument etc.  Or if the money is intended to be put towards something in particular, e.g. a house deposit or university fees, in which case it may be undesirable to hand over full control of the money at age 18.

Another factor to bear in mind is the relatively low annual JISA allowance.  This may not be a problem for ongoing savings but when looking to invest a lump sum such as a gift or inheritance it may be restrictive.

There are two types of JISA available: cash, and stocks and shares.  At the time of writing the best rate available for a cash JISA is 3.5%.  Bearing in mind that the current rate of inflation is 2.7% (as measured by the Consumer Price Index) this does not provide much potential for growth over time.  For those with a longer term horizon (e.g. more than five years until the child turns 18), a stocks and shares JISA provides the potential for capital growth although it must be noted that this is not guaranteed as investments can go down as well as up in value.

Other cash savings

Other children’s savings accounts allow access before age 18 and are usually tax-free as children rarely have sufficient income to pay income tax (children, like adults, have a tax-free personal allowance of £11,850; however, see the important tax note below).  At the time of writing rates of up to 4.5% are available for regular savings of up to £100/month or up to 3% for easy access accounts.

Other investment accounts

Adults can open an investment account to hold stocks and shares on behalf of a child.  The account is designated for the child, so the account holder might be ‘Dr Patel for the benefit of Miss Jasmine Patel’.  There are no limits to the amount that can be invested.

Where the intention is to set up a bare trust, the investments are treated as belonging to the child and are taxed as such (although see the important tax note below).  The funds can be withdrawn before age 18 as long as they are to be used for the benefit of the child.  If not withdrawn, the child becomes legally entitled to the funds at age 18. 

It is possible to set up a designated account without creating a bare trust; however, this does not have the same tax benefits.

IMPORTANT TAX NOTE

Where a parent gifts money to their child, the income (i.e. interest or dividends) will be taxed as if it belongs to the parent if it exceeds £100 a year.  This is to prevent parents using their children’s personal allowances as an extension of their own personal allowance.  Where the money is gifted by someone else, e.g. a grandparent, aunt or uncle, the income is always taxed as belonging to the child.

Pensions

There is no minimum age to start contributing to a pension.  The pension contribution rules are the same for everyone regardless of age: tax relief is available on contributions of up to £3,600 (gross) or 100% of earnings if higher.  For a young child, who we will assume is not earning, the maximum annual contribution is therefore £2,880, to which the taxman will add £720 in tax relief resulting in a gross contribution of £3,600.  A parent or anyone else can gift money into a child’s pension.

Once in a pension, the money will grow tax-free.  The main thing to remember is that pensions cannot be accessed until minimum retirement age, which is currently 55 but is increasing to 57 in 2028 and will track ten years below the State Pension Age thereafter so is likely to be subject to further increases.  So while this is undoubtedly an investment for a child’s future, it’s not one they can access any time soon.

Investment bonds

Investment bonds are offered by life insurance companies.  It is not possible to take out an investment bond in the name of a child so there are two options for using investment bonds to invest on behalf of children: i) the parent (or grandparent or other relation) takes out the bond in their own name and assigns it to the child at any time after they turn 18 or ii) a bond is taken out in trust for the benefit of the child, who will usually become entitled to the funds at age 18.

Within a bond the money is invested in stock market-based investments.  Investment bonds do not pay out an income so the parental settlement rule mentioned above, whereby the parent is taxed if the income on money they have gifted to the child exceeds £100 a year, does not apply.  

Where a bond is held in the adult’s own name they retain control over when to eventually gift the money, if at all.  Bonds are set up with several different segments or policies so the adult can choose to either transfer the whole bond or segments from it to the child after they have reached age 18.  For example, a number of segments could be transferred each year to provide the funds to pay for university fees.  On receipt of the bond or bond segments, the child can cash these in to access the money.  Any gain on the investment is subject to income tax in the hands of the child.

The rate of tax depends on whether it is the bond is based in the UK or offshore.  Investments within a UK bond are deemed to have already been taxed at the basic rate, so a basic rate taxpayer will have no further tax to pay as long as the gain from the bond doesn’t take them into the higher rate tax bracket.  Assuming a young adult is a relatively low earner there is unlikely be a tax charge; however, they cannot reclaim tax if they are a non-taxpayer.

Within an offshore bond the investments are not subject to UK tax so grow tax-free.  The gains are then chargeable on encashment.  However, the child can use their tax-free personal allowances if they have not already been used elsewhere.  For 2018/19 these allowances mean that individuals who receive less than £17,850 in earnings and interest combined won’t have any tax to pay on the income.

Where a bond is held in trust, offshore bonds can be useful because as explained above there is no taxation within the bond so all income and capital gains accrue for the child’s future benefit.  As the bond does not produce income there is no annual tax return for the trust to submit, substantially reducing trust administration.  At 18, the bond can be passed directly out of the trust with no tax consequences for the trustees as any tax liability is assessed on the child.  As above the child can use their available personal allowances, which could mean that all or most of the gains are completely tax free.

Inheritance Tax

It should be noted that gifts to a child as discussed above are ‘potentially exempt transfers’ for Inheritance Tax purposes, if they are not covered by other exemptions such as the £3,000 annual exemption.  Potentially exempt transfers are exempt from Inheritance Tax if the donor survives for seven years after making the gift. 

Advice on investing for children

Please note that this article provides information only on the various options for investing for children and does not provide personalised advice.  If you would like advice on investing for children please contact Richard Higgs CFP FPFS on 0117 966 5699 or richard.higgs@wealthwestmedical.co.uk.

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