Investing for the young
For clients wanting to invest for their children’s future in something more adventurous than a child savings account, there are three main options: Junior ISA (JISA), junior pension or a bare trust investment account.
The purpose of these accounts varies significantly, and there are considerable differences in how they can be accessed, tax treatment, limits on investments and how the accounts are managed.
JISAs are often the first option that springs to mind when we talk about investing for children. Like all ISAs, JISAs benefit from tax free growth, with no Income or Capital Gains Tax to be paid. This includes when the account is funded by parents, and, unlike some other accounts, even when the income for the year exceeds £100 – more on that later.
Children can have a cash JISA and a stocks and shares JISA. It is possible to hold one of each type, and transfers can be made freely from one to the other. However, unlike adult ISAs, it is not possible to open a new account of the same type each year and leave the old one open. If a stocks and shares JISA is held and you want to pay into one with a different provider, then the existing JISA must be transferred to them first.
Accounts can be opened by the parent or legal guardian of any child resident in the UK aged under 18. We are frequently asked whether grandparents can open accounts for their grandchildren, and the short answer is no. Only someone with legal responsibility can be the ‘registered contact’ – the person who opens the account and manages the investments (along with their adviser) on an ongoing basis. In terms of subscriptions, though, these can be made by anyone, so grandparents and other family members are welcome. All subscriptions are classed as gifts to the child, but once the money is in, it’s in. No withdrawals are permitted from JISAs, other than in the case of the extreme heartbreak of the death or terminal illness of the child.
Children born in the UK between 1 September 2002 and 2 January 2011 were eligible for Child Trust Funds (CTFs) and, although these accounts can no longer be opened, they can continue to be held until the child reaches age 18. It is not permitted for a CTF and a JISA to be held for the same child, however since April 2015 it has been possible to transfer a CTF to a JISA if the transfer is made as part of the JISA account-opening process.
Subscription limits for both JISA and CTF are £4,368 for the 2019/20 tax year. This rises annually in line with CPI and is always rounded to be divisible by 12 for those wanting to make regular monthly payments. Although the limits are the same, they are separate allowances and the rules are slightly different. The CTF year runs from the child’s birthday, whereas the JISA runs in tax years. If you are considering transferring a CTF to a JISA, this gives an opportunity for a triple subscription in one year.
Let’s take Josh as an example. Josh’s birthday is 1 October and he currently has a CTF, but his parents are thinking of moving it to a JISA. No payments have been made into his CTF since his last birthday, but his parents have a bit of spare cash and now want to maximise the subscriptions.
They can pay in £4,368 before 30 September and another £4,368 on 1 October in the new CTF year. If they then make the transfer to JISA they can make a further subscription of £4,368 to the JISA once the transfer has completed. This allows a total of £13,104 to be subscribed in one tax year. The next date the JISA could be subscribed to would then be 6 April 2020 at whatever the new subscription limit is for 2020/21.
Even without a bumper year with extra subscriptions, an organised parent who sets up a JISA shortly after their child is born and pays in the maximum at the start of each tax year, could see their child have a fund in excess of £150,000* by their 18th birthday.
A fund that size would make a great 18th birthday present, taking care of university fees and leaving enough for a hefty first house deposit, but parents should be aware that their offspring will be getting a letter from their ISA manager about it automatically converting to an adult ISA and the parental controls are off – an 18 year old can withdraw funds as and when they like.
Turning to pensions now and the option of setting up a scheme for a child. This is definitely one for the long game, and primarily used by wealthy clients who have exhausted the JISA allowance for their offspring. It is possible to pay in £2,880 a year, which will be topped up to £3,600 under relief at source, even when there are no earnings. As a registered pension scheme, the investments can grow tax-free, and the benefits of compounding will be substantial if funding starts for a child, given funds cannot be accessed for a time frame of potentially 50+ years. With relatively low contribution limits, it’s important to look at the charges, as they can have a big impact on small funds in the early years.
It would usually be the parent or legal guardian who would set up the pension and make the investment decisions, but some providers may allow grandparents or other adult family members to do so.
Another use for junior pensions is where a child is a beneficiary after a family member’s death and has funds designated to flexi-access drawdown in their name.
Josh’s grandfather passes away at age 83, leaving a pension fund of £200,000. Josh’s Dad, Simon, is his only child, and is a higher-rate taxpayer. If Simon were the sole beneficiary and funds were designated to flexi-access drawdown in his name, any withdrawals he makes will be taxed at 40% (or higher). Josh is at private school and Simon is paying the fees out of his taxed income. Fortunately, Josh’s grandfather included Josh in his nomination which means some of his pension fund could go into a pension in Josh’s name. Simon can manage the investments and make withdrawals at any time, as long as it is for Josh’s benefit. This means Simon can make withdrawals from Josh’s beneficiary’s flexi-access drawdown fund to pay his school fees. As Josh doesn’t have any other income, the whole of his personal allowance is available so up to £12,500 can be withdrawn tax-free each year (increasing in line with personal allowance).
When Josh reaches age 18, if there are funds left in his pension, then he will take over from Simon in managing his own investments and withdrawals.
Bare trust investment accounts
A child cannot legally own shares, so the easiest way to open an investment account for them is to have a bare trust account. A bare trust document can be very simple, setting out the initial donor, trustees and who the beneficiary is.
Unlike the other type of accounts we’ve looked at, a bare trust doesn’t have to be managed by the child’s parents. They are therefore a popular option for grandparents setting up accounts for the benefit of their grandchildren that they can invest and manage. Bare trusts also allow withdrawals at any age, as long as it’s for the beneficiary’s benefit, so grandparents could invest and make withdrawals to pay school fees as appropriate.
On turning age 18 (or 16 in Scotland), the child-turned-adult has absolute entitlement to all the capital and income, but it isn’t an automatic handover to take over managing the assets. The trustees can continue looking after the fund indefinitely; what changes is the now-adult beneficiary can demand the capital and/or income at any time. If they are comfortable looking after their own affairs, then the trust effectively ends and it becomes an adult investment account.
Although it is possible to set up a bare trust for two or more beneficiaries, it is complex and rarely recommended due to the fact that beneficiaries have absolute entitlement. This can make things difficult when one reaches 18 and demands income, meanwhile their 15- and 12-year-old siblings can’t. All three have entitlement to funds in the account and their split will keep changing, making for some complex calculations for the trustees. It is far simpler for them to have an account each to avoid future family disputes.
As it’s not a tax wrapper like a pension or ISA, there's no limit on the amount that can be invested in a bare trust account. Income and capital gains within the account are chargeable to tax, but are treated as belonging to the beneficiary. A child has the same personal allowances as an adult, i.e. personal allowance, personal savings allowance and a starting rate for savings of 0%, meaning up to £18,500 of income a year could be tax-free plus a capital gains allowance of £12,000.
One crucial point to be aware of, though, is that if a parent puts money into the bare trust account and the income exceeds £100 a year (or £200 if both parents pay in), then the income is taxed on the parents. This is why bare trust dealing accounts are most commonly used for grandparents to make gifts, rather than parents.
Mix it up
Of course, deciding which option is best is not an either/or situation. Simon may decide to set up a JISA to save into for Josh, whilst the grandparents set up a bare trust account as well as leaving provision for Josh to inherit a proportion of their pension assets on death. Looks like Josh is going to be off to a good start.
*Assumes subscriptions increase 2% per annum and 5% growth net of charges