Investing for Your Children

New Junior ISA and other investment vehicles

When investing for children, there are numerous products that could come into play, including the new Junior ISA that is to launch this November. 

Other choices available include Parental ISAs, Child Trust Funds, Bank Accounts, National Savings & Investments, Unit Trusts and Stakeholder Pensions.

When selecting an appropriate investment vehicle for children, you need to consider:

• whether to invest a lump sum or regular premium
• the timescale involved
• the risk profile you’re happy with
• the tax implications of each vehicle

Junior ISA

Launching in November 2011, the Junior ISA allows children to invest in their own name which is currently not possible. 

It will operate in a similar fashion to the adult parental ISA (described below) with the annual limit to be set to £3,000 per year. Within this limit there will be a cash and an investment element.

The child will be able to fully access the funds at age 18, irrespective of your wishes.  It is with this in mind that some parents may prefer to use their own ISA allowances giving them greater control over when the child receives the benefits.

Parental ISAs

ISAs have proved to be very popular because of the tax benefits. Investments need to be in the parents name as they are, currently, not available to children until age 16+. It also allows for more control.

Cash and corporate bonds held within an ISA are tax-free. Dividends from shares within an ISA will have 10% tax deducted, but there is no liability to higher rate income tax and any capital gains are free from capital gains tax.

Many parents invest in ISAs in their own names but earmark the investment for their children. The children obviously have no right to the investment and parents have no obligation to pass on the investment. 

This flexibility may be useful as it does not tie in the parents, unlike unit trusts in a bare trust. 

From 6 April 2011, the allowance in stocks and shares is £10,680 or this can be split £5,340 in cash and £5,340 in equities.

Investments can be made as a one-off lump sum. However, and this is very useful when investing in equities, they can be drip-fed in by way of a monthly contribution with or without lump sum ad hoc payments to maximise the annual allowance.

Doing this reduces some of the risk that fluctuations in the stock markets can bring. It must be stated that, with an equity ISA, a medium to long term view should be taken to allow for the peaks and troughs of the market.

Child Trust Fund

Every child born between September 1st 2002 and December 31st 2010 and receiving child benefit is eligible for a Child Trust Fund. 

The impact of these accounts though has been substantially reduced since the arrival of the Coalition Government. From August 2011, the payment will be reduced down from £250 to £50 for children in more affluent families, and from £500 to £100 for children in lower income families.

The Child Trust Fund account is a savings and investment account for children. The account will belong to the child and cannot be touched until he or she is 18. Money cannot be taken out of the Child Trust Fund account once it has been put in.

Neither parents nor the child will pay tax on any income or gains in the account provided that they are UK residents.

A maximum of £1,200 a year can be saved in this account by parents, family or friends. Each contribution year starts on the child's birthday and ends the day before their next birthday.

There are two types of account, stakeholder and non-stakeholder. Broadly speaking, the stakeholder option caps the annual charges at 1.5% of the account's value but imposes certain investment restrictions. The non-stakeholder is more flexible but can levy higher charges.

Bank Accounts

There are a number of accounts designed for children. Because these will often be held for a relatively long time, they will often offer an attractive interest rate. 

Cash deposits are very low risk. They’re suitable for people who are extremely risk-adverse or who are not concerned about inflation.

From a tax point of view, if the interest accruing in a tax year is less than the child's personal allowance of £7,475 (tax year 2011/12), there should be no tax due.  By completing an R85 form, available from the Inland Revenue or from the account provider, the interest will be received and paid gross.

Care should be taken if the money is a gift from the child's parents. In this situation, any interest above £100 will be taxable for the parents.

If each parent makes a separate gift, they can each use their £100 allowance, thereby allowing interest of £200 to be free of tax. As a result, if a significant gift is to be made, it will often come from grandparents or other relatives as the £100 rule does not apply.

For children's own saving accounts, just like any other form of saving, you should check the following:

• Is the interest rate offered competitive?
• Is there a bonus rate in the advertised interest rate and when does it end?
• Is there a notice period for withdrawals?

The National Savings & Investments (NSI) Child Bond Issue 34

In the NS&I Child Bond Issue 34, you can invest between £25 and £3,000 tax-free for children under the age of 16.

The interest is fixed for 5 years, with the above bond currently paying 2.5% AER including a 5th anniversary bonus.

This is a very low risk investment and proceeds are also tax free.

Unit Trust and Open-Ended Investment Companies (OEICS)

These are collective investments that pool investors' money to allow a wider investment spread: in stocks and share, bonds or other investments. 

Economies of scale mean that the cost of running a collective investment may be less than that for an individual portfolio.

In general, shares should outperform cash deposits and inflation over the medium to long term.

Investment trusts perform a similar function to unit trusts and some have special savings schemes for children. 

Children have their own tax allowances, the same as adults. It is possible therefore to use the child's income tax allowance (£7,475 from 6 April 2011) and capital gains tax allowance (£10,100).

Bare Trusts

Because children are not allowed to hold investments, they are often wrapped in a trust. The simplest form of trust is a bare trust, with the investment held by an adult, usually a parent or grandparent, on behalf of the child.

However, apart from being the named holder (nominee), the parent has no beneficial right to the investment and must exercise control for the benefit of or on the instruction of the child.

The income arising on the investment is taxed as part of the child's taxable income and any capital gains as part of the child's capital gains.

From a practical point of view, the bare trust is extremely easy to administer because there is no trust document. The investment is made in the parent's name and the existence of the trust is denoted by having the child's initials in brackets. 

There is no additional cost in placing the investment in a bare trust.

Stakeholder Pensions - A Pension from Birth

Stakeholder pensions were introduced by the Government as a flexible, low cost, tax efficient way of providing an income in retirement. They also allow for contributions of up to £3,600 a year to be made on behalf of someone else, including children from birth.

As the contributions attract tax relief at the basic rate, an investment of £3,600 would cost only £2,880.

This facility therefore allows for parents and grandparents to start a pension very early in a child's life. Even modest contributions can grow to a meaningful sum over a 50 year period. 

Contributions of £3,600 paid for the first 18 years of a child's life then stopped, would generate a fund of £1,310,000 at age 60 (assuming average fund growth of 7% per year and an annual fund charge of 1%).

Although these figures seem large, savers need to offset the effect of inflation. If we assume inflation of 3% per annum over a 60 year period, the real value of the fund falls to about £222,350. With an annuity rate of 6%, this would provide an income of about £13,350 in today's terms.

It won't solve the child's pension problem, but it’s certainly a step in the right direction!

Stakeholder pensions can therefore offer a useful way of boosting a child's income in retirement. The only downside is that the child cannot touch the money until he or she is age 55.

In the uncertain world of final salary schemes moving forward and schemes like the NHS Pension Scheme, a consideration to "getting in early" in other arrangements is an important option for old and young.

As with everything in life, the secret is to review and react to your circumstances as they occur.

Article by Andrew Morgan
Specialist IFA to Doctors and Dentists at Legal & Medical Investments
May 2011