Finding the best way to save for a child’s future can be tricky, knowing how much can be paid in, whether to save smaller regular amounts or a lump sum, invest in shares or cash are all common questions.
For many parents a key concern is being able to control when the child has unfettered access to the funds. While some 18-year olds may put the savings to good use, others could fritter them away.
When considering whether it should be child pensions or ISAs it is key that a pension investment forbids access until the child is in their late 50s, whereas ISAs can be accessed from 18.
Individual Savings Accounts (ISAs) and pensions enable invested funds to grow tax free. Pensions and Lifetime ISAs have money chipped in by the Government to the savings made. All ISAs can be accessed tax free. 25% of the accumulated pension fund can be paid out tax free but the rest is subject to income tax when drawn. The table below sets out the rules around these plans.
|Feature||Pension||Individual Savings Account|
|Access||Not until age 57/58||From age 18|
|Savings limit per tax year||Up to £2,880 until child has earned income, then lower of earnings or £40,000.||Below age 16 JISA £4,368
Age 16-18 JISA and cash ISA £24, 368
Over age 18 Adult ISA £20,000
of which £4,000 can be paid into a Lifetime ISA from 18 -50 years (must be 18-40 when opening LISA). Lisa cannot be accessed till age 60, penalty free, unless used for a first-time house purchase.
|Government top up||25% added to the savings made. 40%/ 45% if child is a higher rate taxpayer.||No top up for Junior or Adult ISAs,
25% top up for Lifetime ISAs.
|Tax on growth and income in fund||No tax||No tax|
|Tax withdrawals||25% tax free, balance taxed as income.||No tax
25% penalty on Lifetime ISA withdrawals, if withdrawn before age 60 and not used as deposit for first time house purchase.
|Inheritance tax||Not part of estate, can be passed tax free to a nominee||Forms part of estate for inheritance tax.|
Junior ISAs and Child Trust Funds
Junior ISAs (JISAs) were introduced in 2011 but children born between 1 September 2002 and 2 January 2011 had a Child Trust Fund (CTF) with £250 contributed by the government. Parents could add to them and choose a cash or stocks and shares investment fund. CTFs can be converted into JISAs, but you can’t hold both simultaneously. You can still contribute up to £4,368 per annum into an existing CTF. Child Trust Funds mature at age 18. The first of these will become available in September worth an estimated £700 million, with £7.5 billion invested overall.
JISAs can only be set up by a parent or guardian but anyone can contribute to them, subject to the annual limit of £4,368 in 2019/20. They can be in cash or stocks and shares. One significant drawback with both CTFs and JISAs is that the child can manage the account from age 16 and access the funds from age 18.
Children aged 16 or 17 are allowed both a Junior ISA (JISA) and an adult cash ISA so can top up their tax privileged savings with up to £24,368.
Those 18 to 40-year olds who wish to become homeowners can open a Lifetime ISA. It allows up to £4,000 of the £20,000 ISA allowance to receive a Government top up of 25%. Savings can continue until age 50. Providing the proceeds are used for the deposit on a first home, bought with a mortgage, the funds are tax free. If not used for this, funds can be left till after age 60, then withdrawn tax free. If withdrawn for any other purpose before 60, 25% of any withdrawal is clawed back by HMRC. This includes 25% of the saver’s own money, not just the Government subsidy.
Funds cannot be accessed until age 57/58 (10 years prior to State retirement age). The savings receive an automatic 20% uplift, whether the child is a taxpayer or not. Savings can be made from birth to age 75 with the benefit of tax relief at the marginal rate of tax payable by the plan owner. A child who is a higher rate taxpayer may claim an additional 20% /25% tax relief via self- assessment, even though they are not personally funding the savings.
Cash or Stocks and Shares?
The ISA allowance can be invested in a stocks and shares ISA, or cash ISA or a combination of both, with up to £20,000 a year tax sheltered. Only one of each type of ISA can be opened per tax year. Different providers can be used for each tax year. Adding to the same provider’s stocks and shares ISA may produce lower charges, some offer discounts based on fund size, others have fixed fees. Money invested in a stocks and shares ISA can be transferred to a cash ISA and visa versa. To retain the tax privileges of the ISA wrapper the transfer of funds must be from ISA provider to ISA provider, not via a bank account.
While there is no fixed time frame for ISA investment, those investing in stocks and shares ISAs should be prepared to forego access to the funds in the early stages of investment, as these may go up or down in value and are likely to produce better returns over the longer term.
If the savings are needed within three to five years, a cash ISA may provide more stable returns. However, with interest low, cash ISAs are unlikely to beat inflation and will not offer the same growth potential as investment in the stock market. A stocks and shares ISA is more likely to benefit from the long-term effect of compound returns.
Pension schemes can invest in a wide range of assets, shares, fixed interest, commercial property, commodities and cash. Pensions are long term investments and so should be invested in asset backed securities to maintain their value. Savings can be switched between asset classes.
When investing it is important to consider what the savings may be needed for. If only short term, an ISA may not be the best option as many non- ISA deposit accounts pay more interest than cash ISA accounts. Up to £1,000 of interest is tax free for basic rate taxpayers, up to £18,500 for those with no other income.
Lump sum or regular payments?
This will be dictated by affordability and whether you intend to make future savings for other children, yet to be born. The inheritance tax (IHT) treatment of lump sum gifts and regular savings differs. Lump sum gifts are tax exempt if made from the annual £3,000 per donor allowance, with the ability to carry forward the previous year’s unused allowance. Gifts below £250 per recipient are also exempt. Gifts made on marriage are exempt up to £5,000 per parent. All other lump sum gifts are potentially exempt transfers, the gift remains in the estate for 7 years from when made, with its value for inheritance tax tapering by 20% per year after year three.
Regular gifts made from surplus income, over more than one tax year, are IHT exempt, with no upper limit. If investing in asset backed securities, regular savings enable market volatility to be smoothed out and payments can be varied or stopped.
Whether child pensions or ISAs the decision which is easy to make is whether you or they should save at all. The answer, of course is yes.
Further reading: Junior ISAs get good returns from investment companies