Life used to be so simple and you would stroll down to your local building society, open up a savings account and put aside money however you could. Now I know from being in financial services for 17 years that you stroll down the high street now, and if you are lucky enough to have a bank in your town, the choice is endless. Which bank do you open an account with? What type of account do I open? A children’s savings account paying 0.02% gross interest or premium bonds, or a Junior ISA, or a bond? Or what about a Child trust fund – I think my child still has one of those…the choice is endless.
The secret of making the best money decisions can often come from having the right money mindset.
Let’s talk tax – sorry, yes it is necessary!
Let’s be clear about tax. Since 2016, a personal savings allowance was introduced. This is called a PSA. Each child can earn £1,000 each year tax free. Theoretically, they could earn up to £17,850 per year before paying tax. This is made up of their own personal allowance of £11,850 (PA) + £5,000 starting savings allowance (SSR) and £1,000 personal savings allowance (PSA).
- Personal allowance (PA) – this is the amount you can earn without paying any income tax – This allowance is £11,850 (2018/19)
- Then there’s a £5,000 starting savings rate (SSR) where the tax rate is 0% so anything up to this is tax free
- Finally the £1,000 personal savings allowance (PSA)
= £17,850 per tax year
If you give money to a child and the interest generated is more than £100 per year then you would pay tax as the parent on the entire amount. So for example, if I gave little Tommy £50,000 and it paid 1% interest that would be £500 interest. That is over £100, so I may have to pay tax on this. If I had not used my £1,000 personal savings allowance myself on my own savings, then it would be tax free. No tax to pay. But lets say I had my own savings pot of £110,000 paying me 1% interest, the interest of £1,100 would be over my £1,000 PA limit. So I would pay tax on little Tommy’s £500. If I was a higher rate tax payer I would pay 40% tax on £500, i.e £200.
Therefore, in reality you would only consider saving into a Junior ISA in certain situations:
- if you think that you would earn over £1000 per year on your own savings
- you want them to have access to the money at age 18 (as this is a stipulation of a Junior ISA)
- the interest paid on a Junior ISA is higher than a normal savings account
So, assuming that we forget Junior ISAs for these reasons, let’s look at a comparison of some best money savers for your kids.
Money Saver No 1 – Use your own ISA allowance
Having a Junior ISA automatically entitles the child to have access to that many at age 18. This could be a troublesome age to pass money to a child. The first question I always ask people when they ask about using ISAs to save for kids is, do you want control? Control as the parent. If the answer to this is yes, then considering saving in your own name could be a great choice. You could use your own ISA allowance, currently £20,000 per annum. Here are some of the pros of this method:
- You have complete control as to when they have access to the money
- You can add money as and when you please (subject to minimum amounts with each provider)
- If you do not want the child to have the money at age 18 (which is what happens with a Junior ISA), you have control of this
- If you have a partner, you can utilise your £20,000 allowance each making a total of £40,000 per tax year
- It grows tax free
The downsides are:
- It uses your own allowance which would be a pain if you are close to exceeding your annual limit for your own savings
- If something happened to you, this money would not automatically pass to the children. Warning! You must make a will
- It would form part of your estate on death which could cause problems if your estate is worth more than the inheritance tax threshold
Money Saver No 2 – Stocks and Shares ISAs
Your £20,000 allowance can be made up of cash or stocks and shares. Which is best?
Cash ISAs +
- Instant access (or after a fixed period)
- Receive a variable or fixed interest rate
- Great for emergency funds or short term homes for savings
- Readily available
Stocks and Shares +
- Much better opportunity to grow over the longer term
- 1000’s of investment funds available at low cost
- Investments ranging from low risk (yes you don’t have to accept high levels of risks!) to more adventurous
- Access is normally gained within just a few days (gone are the old style investment days of having no access)
Think about your purpose for saving. If it is for short term savings that you plan to spend then cash is absolutely the best choice.
If you want to save for the longer term (anything of more than around 5 years+) then consider stocks and shares. Don’t let the fear of risk put you off. Invest some time in having a conversation with a money coach or a financial adviser to understand the risks involved. The Money Panel offer a coaching session on risk to help you understand what risk really means.
Money Saver No 3 – Consider a switch
Millons of people own ISAs and rarely review them. There are now so many types of ISAs it makes life a little more complicated.
Do you have a Child Trust fund?
6 million children have a Child trust fund (CTF). If your baby was born between 1 September 2002 and 2 January 2011, they were given £500 or more by the government. Further contributions can still be added of £4260 per annum and any interest is tax-free. These accounts were superseded by Junior ISAs, so are no longer available. My eldest son just missed out on these by two months (knew I should have pushed the family planning forward!)
Since April 2015, if you had one of these, you can now convert them into a Junior ISA. There are two types: cash and stocks and shares.
Should you transfer a Child Trust Fund in cash to a Junior cash ISA?
Yes! There is no real downside to transfer. Junior Cash ISA rates are more competitive than CTFs. They have the same annual allowance of £4,260. Here are the top junior ISA buys.
What if I have a stocks and shares Child Trust Fund?
If you chose a stocks and shares child trust fund, good for you! Saving over the longer term which is what you are doing with this type of savings (in fact 18 years!), you will need to consider a few others things:
- Dig out your latest statement, the one that you just filed away last year! See if there are any charges to transfer away to another provider.
- What are the investment charges and any associated costs
- You are likely to have much greater investment choice with a Junior stocks and shares ISA
It is highly likely that the charges on a Junior stocks and shares ISA will be lower than a child trust fund but it is worth checking.
Once you have decided to switch from a Child Trust Fund to a Junior ISA there is no going back.
How do I transfer from a Child Trust Fund to a Junior ISA
You cannot have both a Child Trust Fund and a Junior ISA – that would be greedy!
So here are 5 steps to transfer:
- 1 – Choose who you want to open the new Junior ISA with
- 2 – Check the new provider accepts a transfer in
- 3 – Approach the NEW company and request a transfer (this is normally done with a transfer in form)
- 4 – The new provider will transfer the money to the new account
- 5 – The old account will be closed
ACTION – Add a diary note for 12 months to review the rate you are receiving on the cash ISA or review your investment selection.
You can choose to transfer all or part of the amount held in the child trust fund
Money Saver No 4 – Pensions for kids
On the topic of longer term savings, how great would it be to save money into a pension for your child and hand them a gift at the age of 18 as a head start for their own long term future. It is never too early to start planning. Think about passing on healthy savings habits to your children. You do not have to pay tax to be eligible for the tax benefits of a pension. Here are 10 reasons for starting a pension for your kids:
- Give them a head start
- At age 18, the money passes to them and they can take benefits from age 55 (under current rules)
- At age 18, they could continue to contribute or leave it invested to grow
- The taxman tops up any contributions you may by at least 25%
- Full Control – Stop and start contributions, just like a gym membership!
- Low start contributions from as little as £25 per month
- The money invested grows tax free
- You can contribute a maximum of £2880 per tax year and the government will increase this to £3,600. (That is £720 of FREE money!)
- No impact on your own contributions to pensions
- Ring-fenced under a pension trust so won’t form part of your estate for inheritance tax purposes
Given the long term nature of pensions, there are some downsides.
- Legislation is likely to change and therefore this could impact on the rules and benefits
- Access (under current rules) is from age 55
How do I set up a children’s pension?
For simplicity, you could look at a Stakeholder pension.
Alternatively if you want more investment choice, try an online provider such as Bestinvest, AJ Bell or Hargreaves Lansdown. Some providers call them ‘Junior SIPPs’ which is basically the same thing! A SIPP is a self invested personal pension which just allows more investment choice. A SIPP is typically more costly to run than a Stakeholder or personal pension.
A parent or grandparent can open a children’s pension and invest on behalf of other children provided you supply details of their legal guardians.
You will need the child’s name, date of birth and national insurance number (if they have one). The child doesn’t have to sign the application – they need not know anything about it!
We will be writing another blog about investment choices shortly so watch this space!
If you would like some help setting up savings or pensions for your children, please get in touch.
We can help to guide you through the pro’s and con’s and help you make a decision about what to consider and the steps to set one up!
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