Saving is a Very Fine Thing

Lanying Burley and Mike Fosberry give a round-up of practical advice when investing for children

If you are looking to put money aside for your children or grandchildren, whether it is simply for building up a savings pot for them or to pay for school or university fees, there are a number of tax saving investments and vehicles to consider. Each holds different attractions depending on personal circumstances and attitude to risk. This article looks at some of the options.

Junior ISAs
Junior ISAs are a welcome addition to the range of investment options available for children. As a tax-free savings vehicle they’re likely to be attractive to parents as a way of helping to fund future university fees or a deposit on a first property. It’s possible for eligible children aged 16 or over to open a Junior ISA themselves, but in most cases, subscribers will be parents or grandparents.

Junior ISAs allow parents, family members and friends to make savings on behalf of a child up to the annual subscription limit. For this tax year the maximum subscription amount is £3,600. They are available for children resident in the UK who were born:

  • on or after January 2011, or
  • before September 2002 and are under 18, or
  • between these dates, and do not already have a Child Trust Fund.

Withdrawals from a Junior ISA cannot be made until the child’s 18th birthday, when it is normally converted into an adult ISA.

National Savings
Children’s Bonds from NS&I, the Government-backed savings organisation, allow you to invest for a child’s future in their own name. There is no tax to pay on the interest. The current 35th issue guarantees a compound rate of return of 2.5% AER over five years. The bonds can be cashed in early if necessary, with a penalty equivalent of 90 days’ interest but they should really be viewed as a five year investment. The maximum investment is £3,000 per issue and a parent, guardian and (great) grandparents can invest for anyone under 16. Bonds cannot be held beyond the child’s 21st birthday.

Another option through NS&I is Premium Bonds. The maximum investment is £30,000, but with odds of 24,000 to 1 and a current rate for the prize fund of 1.5%, this may not be a gamble that those investing on behalf of children are willing to take.

Stakeholder pensions
For much longer-term savings, stakeholder pensions for children are an attractive option to help build up a pension pot over time. Funds cannot be accessed until age 55 so clearly this is a very different time horizon, but it’s worth bearing in mind that the State is unlikely to provide very much in pension terms in the future, so the earlier pension saving starts, the better.

Setting up a pension for children or grandchildren can be a good way to start them on the savings path, although it must be appreciated that the value of the pension fund can go down as well as up, depending on the actual investment fund that is used.

Up to £3,600 per year gross can be invested on behalf of a child in a stakeholder pension. Tax relief at source is available at the basic rate of 20%, regardless of whether the person paying is a taxpayer, so the amount actually paid is £2,880.

Remember that pension funds are virtually tax exempt as far as the underlying investments are concerned and it is sensible to consider this type of arrangement if you want to make regular payments each year. Over time, this should accrue to a meaningful sum.

Offshore investment bonds
These bonds can be a useful way of providing funds for university fees or a gap year. They can also be used to help fund school fees prior to age 18 by using the annual tax-free withdrawal allowance of 5% of the initial investment. This involves the investment of a capital sum through the medium of an offshore investment bond run by insurance companies, normally based in Dublin or the Isle of Man, and can be in a parent’s name.

Depending on the investment funds chosen, the value of the investment can go down as well as up and there is a risk that the investor may not receive a return of all the capital invested.

The capital is invested in underlying investment funds selected by the investor.

Investments are largely free of tax, other than withholding taxes, which are non-reclaimable.

Once the child is 18 the bonds can be assigned to them and, as long as they are non-taxpayers at the time, it’s normally possible for them to surrender the bonds without any tax liability.

Some offshore bond providers also run regular savings schemes which are a useful way of building up funds in the same tax efficient offshore environment and probably best suited to meeting future University fees.

Gifts from grandparents
Another very useful way of saving for future school fees, particularly for younger children, is through gifts from grandparents. A capital gift from a grandparent is extremely tax efficient compared to parental gifts, where income above £100 is taxed on the parents.

Grandparental gifts can be invested in the child’s own name or within a bare trust as the capital is treated as the child’s, so that any income is taxed on the child and any gains are subject to the child’s own individual CGT allowance (£10,600 in the current tax year).

Bearing in mind a child will also have a personal tax allowance (currently £8,105), it is unlikely that he or she will in fact pay any tax on investment income unless substantial capital gifts are involved.

Regular Savings Vehicle
Banks and building societies also offer regular savings accounts for children. They usually require a minimum amount of money paid in each month and in return they will often pay a higher amount of interest.

For those who can take a longer term view for their children’s or grandchildren’s savings and are happy with some investment risk, equity based investments can be attractive. An investment can be made as a lump sum but if you do not have enough put aside or you prefer to drip feed money in on a regular basis there are a number of investment trusts which provide savings schemes and you can invest in a range of funds. Payments are usually made on a monthly basis which can smooth out the highs and lows of the market thus providing you with the beneficial effect of pound cost averaging. There are a wide range of funds available which will invest in differing assets and both UK and overseas markets.

This is just a brief run through of some of the opportunities available. It is important to take advice to ensure that the options you consider are relevant to the particular objectives and risk profile you have in mind when investing for children.

Disclaimer
By necessity, this briefing can only provide a short overview and it is essential to seek professional advice before applying the contents of this article. No responsibility can be taken for any loss arising from action taken or refrained from on the basis of this publication. Details correct at time of writing.

Risk warning
Investment does involve risk. The value of investments and the income from them can go down as well as up. The investor may not receive back in total the original amount invested. Past performance is not a guide to future performance. Rates of tax are those prevailing at the time and are subject to change without notice. Clients should always seek appropriate advice from their financial adviser before committing funds for investment. When investments are made in overseas securities, movements in exchange rates may have an effect on the value of that investment. The effect may be favourable or unfavourable.

Lanying Burley and Mike Fosberry of Smith & Williamson, the investment management and accountancy group

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