Welcome to the Money Agony Aunt series where we address some of the most commonly asked money questions.
Question: I want to start investing for my child. Where do I start?
Answer:
The first thing to consider when it comes to financial advice on investments for your child is whether you want them to eventually take ownership of the investments.
While a child is a minor (under 18), they usually don’t have access to investments in their name. At 18, they legally become an adult and can have access to some products in their name such as a Junior ISA.
Sometimes parents can be wary about what their 18-year-old might do with an investment pot. This is something you should definitely consider when choosing how to invest for your child.
The second thing to consider is whether you want access to any money that is saved or invested for your child. For example, monies in a Junior ISA usually cannot be accessed until the child is 18, even if it would be used for school fees or to help with the family’s living costs (such as mortgage payments). So it’s worth giving some thought as to what you’re saving or investing for.
Now let’s look at some common investment products for children.
Accounts in the child’s name
- Junior ISA
The Junior ISA is similar to the adult ISA, but for minors. It’s similar to an adult ISA because:
- You can hold cash or investments and there are two types: Cash, and Stocks & Shares
- It’s a tax wrapper – monies or investments in the account are not subject to income, capital gains or dividend tax
- There’s also an annual allowance – the maximum annual contribution is currently £9,000
The account in the child’s name needs to be opened by the child’s parent or legal guardian. Once set up, anyone can contribute to it such as grandparents, godparents, family friends etc.
The money in the account cannot be accessed until the child is 18, apart from in exceptional circumstances. This means that the Junior ISA tends to be more suitable for growing a pot for when the child is older rather than saving towards school fees or any goal before the child is 18.
At 18, the child is free to withdraw from their account. This can be a worry for parents, and is a major potential drawback of the Junior ISA. On the flip side, once the child is 18, the Junior ISA can be converted into an adult ISA which can be a significant benefit.
- Child SIPP (self-invested personal pension)
This account has a much longer timeframe in mind. The Child SIPP (also known as a Junior SIPP) is essentially a pension pot for your child and shares some similarities with the adult SIPP:
- It’s a tax wrapper with investments shielded from income, dividend and capital gains tax
- Contributions attract tax relief of 20% though there is a limit of £2,880 per year
- Withdrawals can only be made when the child is 55 years old (due to rise to 57 in 2028)
Once the Child SIPP is set up by the child’s parent or legal guardian, anyone can contribute to it including grandparents.
If you make the maximum contribution of £2,880 in a year, 20% tax relief means you will effectively gain £720 bringing the total to £3,600.
The Child SIPP is in the child’s name and can be managed by an adult until the child reaches 18. They can then manage their own account, but – and here’s the potential advantage for wary parents – they won’t have access to the funds within the SIPP until much later in life.
- Bare trust
A bare trust is an option particularly when someone that is not the parent would like to contribute.
Why is that?
Income and capital gains are taxable against the beneficiary of the trust – in this case, the child.
However, if the parent contributes to the bare trust and it generates income of more than £100, then the income becomes taxable against the parent. So if the contributing parent is a higher-rate (i.e. 40%) taxpayer, then income generated by the bare trust will be taxed at 40%.
On the other hand, let’s say a grandparent contributes to the bare trust. In this case, income would be taxable against the child, and the bare trust can generate income up to the child’s personal allowance of £12,570 a year (in the absence of any other income) without triggering income tax. That could be a significant tax benefit.
But why bother with this additional tax complexity when there are Junior ISAs? Well, a bare trust has two key advantages:
- It’s unlimited in size (Junior ISAs only let you invest up to £9,000 a year)
- Any investment and monies within the trust can be accessed for the child’s benefit before they turn 18
The last point is important. You can save for a child’s future, but still be able to access funds should the child need them before they turn 18. This might include paying for education.
As with the Junior ISA, when the child turns 18, they’ll be able to access money from the trust and do as they wish with it.
Transferring to an adult ISA: When the child turns 18, they can roll the entire amount from their Junior ISA into an adult ISA. However, to transfer money from a bare trust to an adult ISA, they’re restricted to the annual ISA allowance (currently £20,000 a year).