As a parent you will want to ensure that your child has the best possible start in life. Many factors will be out of your control but helping your children out financially is one thing that you can plan for whether it be funding school or university fees, helping them to buy their first car, starting a wedding fund or building a deposit for a first home. What options are available if you want to save something in your child’s name that you look after for them?
With the Government announcing that Child Trust Funds will be abolished from January 2011, you may be wondering where to start. There are many factors to consider such as the type of savings product, how often you make payments and the tax implications. And importantly, how much can you afford to save?
Children’s Bank Accounts
Most banks and building societies offer children’s savings accounts. These operate in a similar way to adult savings accounts and there are various types available, with the rate of interest differing depending on the individual product and provider.
Children, like adults, have their own income tax allowance: £6,475 for the tax year 2010/2011. Interest on their savings account can be paid gross (without tax being deducted from the interest) by completing a form R85 which you can pick up from most bank and building societies. This can also be downloaded from HMRC’s website.
If a parent or step-parent decides to save on behalf of their child and more than £100 interest a year is produced, that interest will be taxed as the adult’s income even though it has been paid gross to the child. The adult has to include it in their tax return. This rule does not apply to money invested by grandparents or other family members.
Government Savings Products
National Savings and Investments (“NS&I”) offer a number of tax-free products which are suitable for children: Children’s Bonus Bonds, Premium Bonds and Indexed-Linked Savings Certificates.
Children’s Bonus Bonds are only available to children under 16. An additional bonus is paid if the Bond remains untouched for 5 years. The Bonds are available in “issues”, each having its own rate of return. For example, Issue 34 (on sale as at 26 July 2010) offers an interest rate of 2.50% pa/AER. Between £25 and £3000 can be invested in each issue.
Like an adult, a child can also own between £100 and £30,000 of Premium Bonds. Interest is not paid on Premium Bonds. Instead, each Premium Bond is entered into a monthly prize draw, with prizes ranging from £25 to £1,000,000. Any prizes won are completely tax exempt.
A child can also invest between £100 to £15,000 in Index-Linked Savings Certificates for a 3 or 5 year term. If the child is under the age of 7, these must be purchased by someone else on their behalf. Index-linked Savings Certificates are guaranteed to keep up with inflation, with a guaranteed rate of interest.
Due to over-subscription, there are currently no Index-linked Savings Certificates on issue. However, National Savings and Investments have indicated that new issues will be available in the future. No specific date is available at this time.
Individual Savings Accounts (“ISAs”)
A child can open a cash ISA at 16 and a stocks and shares ISA at 18. Until then, a parent can use their own allowance (£5,100 for a cash ISA or £10,200 for a stocks and shares ISA) as a way to save for their children even though the ISA has to be in their name, not the child’s. ISAs are tax efficient investments and are not subject to income or capital gains tax. It is worth shopping around as the return on ISAs varies between providers.
You might want to invest directly in ‘stocks and shares’ for your child. When you invest in the stock market, there are more risks involved, and crucially you need to understand that the value of your shares can go up and down. This risk has to be weighed against the possible returns and is an important consideration. A less volatile option could be to buy what are known as collective investments. The Fund you buy has itself many different underlying investments so that you are more sheltered from the risk of any one company’s poor performance. Investments can be bought in the child’s name which you look after for them. Children have the same capital gains tax annual allowance as an adult: £10,100 currently.
Starting a pension for your child may seem an unusual savings option. However, under current pension laws, anyone can save up to £3,600 per year in a pension scheme on behalf of a child. Contributions attract tax relief at the basic rate, currently at 20%. In other words, the contributor pays £2,880 into the scheme, and the pension fund claims tax relief of £720 from the Government to top up the contribution to £3,600. You can set up a pension and pay the contributions for any number of children under 18. Money is invested for the long term though, and cannot be accessed until the child reaches 55 under current regulations.
Existing Child Trust Funds
If a Child Trust Fund has already been opened (or if you have already received the voucher from HMRC), this can still be used, and family and friends can continue to invest up to £1,200 a year. The tax free element will also continue which means that no income tax and capital gains tax is payable on sums invested. The child will be able to access funds at age 18. The Government will not however make any additional payments to the account.
A Note of Caution…
If you save for your child then you hope that the pot will grow over time. However, you need to remember that a child is classed as being an adult with legal capacity in Scotland at age 16. They can insist that any assets held for them must be transferred to them. Depending on how much you see yourself investing for your child, you may want to consider setting up a trust for your child to hold the investments or savings. This would ensure that the capital is protected and managed properly for your child and they cannot access the capital directly at too young an age. How much would you feel comfortable with your 16 year old getting their hands on?!