Investing for the next generation
In the UK, it is forecast that £5.5 trillion will be transferred through the generations over the next 30 years.1
So how might people consider saving for children or grandchildren? Three of the most common ways to invest for children under 18 are through ISAs, SIPPs and bare trust investment accounts. Here I’ll look at some quirks and pitfalls of the most commonly used account types.
Junior ISAs (JISAs) are individual savings account specifically for children. Unlike adult ISAs, anyone can pay into them (rather than just the account holder), but an annual subscription limit applies which is currently £4,368 (2019/20).
Both a cash JISA and a stocks and shares JISA can be opened for a child but only one of each type can be held at any one time. Any investment growth is tax-free and the child can access the funds from 18 onwards, which may be useful for university fees or a first car.
If the objective is a house deposit, then a Lifetime ISA is likely to be the preferred option. However, it’s worth noting that a child cannot open a Lifetime ISA until they are 18.
Another benefit of a JISA is that it can be used to receive a transfer from a Child Trust Fund (CTF). Here, though, there are a few key points to be aware of:
- The transfer must complete within 60 days of the JISA being opened, otherwise the JISA must be closed and any subscriptions removed.
- The CTF must be transferred in full and closed.
- Subscriptions cannot be made to the JISA until the CTF transfer has completed.
In order to prevent any unnecessary delays with the transfer, it’s important to note that the registered contact must be the same for both accounts. In our experience, the CTF and JISA having different registered contacts is one of the most common reasons why CTF transfers are held up.
From a planning perspective, a serendipitous quirk in the ISA rules allows for an individual aged 16 to make use of the annual subscription limit of the JISA and that of an adult cash ISA until they reach 18.
This is because a cash ISA can be opened when the child turns 16 and the JISA limit can still be used up to the age of 18. This essentially means subscriptions exceeding £24,000 can be made each year in that period.
A pitfall in the JISA rules is that only the parent can control the account, therefore grandparents and acquaintances cannot.
We tend to think of SIPPs as primarily ‘adult’ pensions, typically used when clients are consolidating lots of smaller pension pots into one place. However, many SIPP providers offer junior versions that can be used as a long-term investment for children.
The main benefit that a SIPP brings to the table is the tax relief that can be claimed on contributions up to a certain limit. The amount that can be contributed, and be eligible for tax relief, into the SIPP is restricted to the lesser of 100% of relevant UK earnings or £3,600 (gross). For the vast majority of children this will be £3,600.
As with a JISA, anyone can pay into a child’s SIPP, assuming the contributions limits aren’t exceeded. It is also worth bearing in mind that any fund held within the SIPP cannot be withdrawn until the individual reaches their normal retirement age. This may be useful if, for example, family members want to give funds to the child but are concerned about the funds being (mis)used at 18.
Also referred to as an ‘Absolute Trust’, this is the simplest form of a trust. Many providers will allow clients to establish investment accounts within a bare trust structure.
These types of accounts are typically used to receive funds gifted to a child, often by grandparents, and there are no limits like there are for JISAs, so larger amounts can be paid in. A gift will be classed as a Potentially Exempt Transfer (PET), which means that it could be outside of the settlor’s estate after seven years.
The child has an absolute right to the funds and can access them when they turn 18. Before then the parents, or grandparents, look after the funds as trustee(s) and invest the funds accordingly. The funds can also be accessed before the child turns 18 if required for the benefit of the child, such as for school fees, so are not locked in like they would be for a Junior ISA.
One advantage of a bare trust is that any income/gain is treated as the child’s own and subject to their own allowances.
An important consideration, and a potential pitfall, in regards to the taxation of withdrawals from a bare trust is the ‘£100 parental settlor rule’. This applies specifically when the settlor of the bare trust is the parent of the beneficiary child and the income arising from gifts made by the same parent to that child exceeds £100 gross in a particular tax year.
The result is that any income will be taxed as income on the parental settlor at their marginal rate, rather than at the child’s marginal rate, which would usually be the case.
Whichever option is chosen, one thing is for sure: the earlier we invest for the next generation the stronger the foundations will be for an independent and wealthier adulthood.1The Centre for Economic and Business Research, ‘Passing on the pounder, the rise of the UK’s inheritance economy’.