Investing for children: five myths debunked
1. Children don’t pay tax
Contrary to popular belief, children are liable for tax, although few are fortunate enough to earn enough on their savings and investments to actually pay any.
There will only be tax to pay by your child if they earn above their personal allowance. The standard personal allowance is currently £11,000, so there won't be any tax to pay as long as the interest they earn amounts to less than £11,000 in the current tax year.
However, the rules are tougher if the interest is earned on money from a parent. If your child earns more than £100 in interest in any tax year from money you have given them, then you will be personally liable for tax on the interest earned, if it's above your personal allowance.
The good news for grandparents, aunts, uncles, godparents and anyone else who gives money to a child, is that the same tax liability does not apply.
2. Children can’t have a pension
Actually, they can and you can start saving into a Junior Sipp as soon as your child or grandchild is born. Each child can have a total of £3,600 a year, or £300 a month, saved into a pension.
Just as with your pension, the government automatically tops up payments you make by 20 per cent, so for your child to have the maximum £3,600 a year, total contributions only need to come to £2,880.
Our calculations show that if you were to invest £300 a month into a Sipp just for the first 18 years of their life (even if they added nothing themselves during their adult life) they would have a very impressive £603,441 pension pot at the age of 65.
This is perhaps the ultimate way to make sure your child has the makings of a secure financial future.
3. If you give your grandchildren money, you’ll pay tax
This is another fallacy and the good news is that you won't. While parents who save or invest money on their children's behalf can face a tax bill if their child's savings or investments earn more than £100 in any tax year, the same does not apply to you when you're a grandparent.
Given the length of time ahead of them, investments in funds are especially worthwhile for children. You invest in your name then add the child's name or initials to the account so you can 'designate' or identify which assets are theirs.
Then you can transfer the assets to the child when they reach age 18. Unlike Isas and pensions, any investment growth will be subject to capital gains tax but this can often be offset by the child's tax allowances.
4. Your child can’t get their hands on the money
Not quite. With a child trust fund or Junior Isa as soon as they hit 18 their account is automatically rolled over into an adult Isa. It's at this point that parents and grandparents often panic.
What if all those years of saving and investing end up getting blown on a gap year or something totally inappropriate and not the purposes you've had them earmarked for in your mind for the past 18 or so years?
Well, if you have a wilful 18-year-old on your hands, then you might find yourself fighting a losing battle.
But making a point of talking about your child's savings and investments with them from as early an age as you can, getting them involved and showing them how it's growing nicely over the years is a good way to instil a savings habit in them that - you hope - will pay off.
5. Once they reach 18 the Jisa has to be cashed in
Yet another myth. Just like you, the government would ideally like to see your now adult child continue to save. That's why the account is automatically converted to an adult Isa.
This way, it's hoped that if the money isn't needed for anything else, it will continue to grow and be added to. Your adult child will now be free to fully invest in a regular stocks and shares Isa as well as adding to anything they hold in a cash Isa.
Before that point, once they reach 16 they can also contribute into the adult equivalent of a cash Isa (although not an adult stocks and shares Isa yet), up to the £15,240 limit in the 2016/17 tax year. This is in addition to any money paid into their Junior Isa.
- Tom Stevenson is investment director for Personal Investing at Fidelity International.
This article was originally written for our sister publication, Money Observer.
Like a self-select ISA but for pensions, self-invested personal pension is a registered pension plan that gives you a flexible and tax-efficient method of preparing for your retirement. It gives you all sorts of options on how you put money in, how you invest it and how it’s paid out and offers a greater number of investment opportunities than if the fund was managed by a pension company. SIPPs are very flexible and allow investments such as quoted and unquoted shares, investment funds, cash deposits, commercial property and intangible property (i.e. copyrights, royalties, patents or carbon offsets). Not permitted are loans to members or people or companies connected to the SIPP holder, tangible moveable property (with the exception of tradable gold) and residential property.
Invidivual Savings Accounts were introduced on 6 April 1999 to replace personal equity plans (PEPs) and tax-exempt special savings accounts (TESSAs) with one plan that covered both stockmarket and savings products, the returns from which are tax-exempt. The ISA is not in itself an investment product. Rather, it’s a tax-free “wrapper” in which you place investments and savings up to a specified annual allowance where the returns (capital growth, dividends, interest) are tax-exempt (you don’t have to declare ISAs and their contents on your tax return). However, any dividends are taxed within the investment, and that can’t be reclaimed.
Capital gains tax
If you buy an asset – shares, a second home, arts and antiques – and then sell it at a later date and make a profit, that profit could be subject to CGT. You don’t pay CGT on selling your main home (which is why MPs “flipped” theirs so regularly) or any securities sheltered in an ISA. Individuals get an annual CGT allowance (£10,600 in 2010/2011) but if you have substantial assets it’s worth paying an accountant to sort it for you.
Available from 1 November 2011, the Junior ISA will replace child trust funds (CFTs), which have been phased out. Junior ISAs will have a £3,000 limit and will be offered by high street banks, building societies and other providers that currently offer ISAs to adults. You can invest in either stocks and shares or cash. But, unlike CTFs, there will be no government contributions into each child’s savings pot. Money invested in Junior ISAs will be “locked in” until the child is 18, and the ISA will default to an adult one.