- Financial planning
- 5 minute read
Over the past couple of decades, investors have become more focused on setting aside money for children. There are a couple of reasons for this. The first is that today’s youngsters seemingly face a more expensive future than their parents and grandparents.
The Institute of Fiscal Studies, for example, has calculated that the average graduate leaves university with a debt of more than £50,000. Meanwhile, the average price of a house in February 2020 was £230,332, according to the UK House Price Index – with this figure climbing to £476,972 in London. In addition, research by You and Your Wedding magazine suggests that today tying the knot typically costs more than £30,000.
The other reason why people are saving for children is that new investment wrappers have been launched specifically for this purpose. Back in 2002, the government introduced tax free child trust funds (CTFs) specifically to encourage saving for children. The first CTFs started to mature in September 2020 as the account holders reached maturity. In 2011, CTFs were replaced by junior ISAs (JISAs), which have continued to this day.
JISAs can be used for investing in stocks and shares, as well as cash. They have an annual allowance of £9,000 for the 2021-22 financial year and any gains are free of both income and capital gains tax. This makes them a very tax-efficient way of saving for children.
In light of the eye-watering costs facing today’s young people, and the opportunities to save for them, it’s not surprising that many parents and grandparents are choosing to set money aside for the younger generation. But while JISAs are a tax efficient means of doing this, they are not necessarily every investor’s wrapper of choice. One disadvantage is their lack of flexibility: the funds cannot be withdrawn until adulthood. Another – in the eyes of many investors – is that children can legally take control of them from the age of 16 and they can withdraw from them aged 18 onwards. This means they can make their own investment choices and use the accumulated funds as they wish.
As this is a worry for some, there are alternatives to consider that can give parents and grandparents more control over when and how their money is used. What are these options?
Bare trusts versus discretionary trusts
Investors who want to retain some control over the investments they make for the children in their family can opt for either a bare or a discretionary trust. Inevitably, both ownership structures have advantages and disadvantages.
Where investors are saving for school fees or other childhood costs, it makes sense to consider a bare trust. As per JISAs, the child with a bare trust has the legal right to the assets in the trust when he or she turns 18 (16 in Scotland). Unlike JISAs, however, the funds from the trust can be withdrawn at any time provided they are used for the benefit of the child – which is why they can cover the costs of education. Also, grandparents can set up bare trusts, but JISAs must be set up by a child’s parents or legal guardians.
There are no limits on how much money can be put into a bare trust and assets are taxed as if they belong to the child, which usually means limited tax on income or gains. This is only the case if you are not the parent of the child. If you are and if it produces more than £100 of income it will be treated as yours for tax purposes.
Designated accounts are a similar option to bare trusts. They can hold investments such as unit trusts and shares for the benefit of a child. If you retain personal ownership of the investment, it will be your tax rates that apply as opposed to the child’s.
Discretionary trusts are more flexible than bare trusts. A discretionary trust is set up for a number of potential beneficiaries, which could be a group of grandchildren. The trustees decide who receives the income generated by the investment, as well the timing, size and recipients of any capital payments. There are drawbacks to discretionary trusts, however. For starters, the income and capital gains tax treatment is often less favourable than with a straightforward bare trust and complex inheritance tax issues can arise. Discretionary trusts also tend to come with a heavier administrative burden, including the requirement to complete trust tax returns.
Junior SIPPs are self-invested personal pensions for children that can only be set up by parents and legal guardians. Nevertheless, anyone can put money into a junior SIPP, provided total contributions – including basic tax relief from the government – do not exceed the annual allowance of £3,600. With no tax on income and gains, a very small investment in a junior SIPP today could potentially mean that your child or grandchild retires with a significant pension pot. Tax could be payable on funds the child withdraws from the SIPP once they retire, however. The parent or guardian will make investment decisions for the SIPP until the child turns 18. Since the child will not be able to access the funds until retirement, a SIPP cannot be used to cover the cost of an overseas gap year, a lavish wedding or the deposit on a first home.
Weighing up the options
There are many ways to invest for children – including options that are not listed here. When deciding how you want to save for the next generation, you should consider a number of factors, including how you want the money to be used, when you want it to become available to them, and how you plan to manage your own tax affairs. A further consideration is that saving for children is usually a long-term strategy that presents a broad range of investment options. For this reason, it can be helpful to involve a financial adviser early in your decision-making process.
Please note that any tax benefits will depend on your personal tax position and rules are subject to change. The value of any investment can go down as well as up and you may get back less than you invested.
To find out more about investing for children, request a call back from one of our expert advice team.