Maximising tax wrapper allowances for children

With some careful timing, there are ways to make the most of tax wrappers for children. Martin Jones, Technical Team Leader at AJ Bell, explains.

While many clients will have tightened their belts over the least year or so, there is a significant group who will find themselves with surplus cash given that typical spending activities have been largely restricted during lockdown.

These clients might look at this as an opportunity to fund their own pensions and ISAs. But the area I want to focus on here is the tax wrapper opportunities available for their children, particularly with regard to ISAs.

If you bear in mind that children’s investments potentially have a very long-term investment horizon, there is a lot of tax-free compound growth to be had, and this could be boosted by some early ‘over-funding’.

Child Trust Funds and Junior ISAs – triple funding

The first opportunity relates to Child Trust Funds (CTFs). These are tax-free savings accounts that were open to children born between 1 September 2002 and 2 January 2011. Eligible children received an initial payment from the Government of £250, which was paid directly to the CTF.

CTFs never really captured the public’s imagination in the way it was hoped, and they were effectively replaced by Junior ISAs (JISAs), which many viewed as being more flexible.

However, there are still millions of CTFs in existence, and while it’s no longer possible to open a new CTF, it’s still possible to pay into an existing CTF given they continue to have their own annual tax-free allowance (£9,000 in 2021/22).

And thanks to a rule change in 2015, clients can transfer their CTFs to JISAs.

Therefore, even if your client has paid nothing into the CTF since the initial £250, it offers a nice opportunity to squirrel funds away tax-free and then roll them into a JISA.

They key technical point to know here is that the allowance period for CTFs runs in line with the child’s birthday rather than the tax year. This means it’s possible to put away three tax-free allowances in a short space of time.

Example

Jenny opened a CTF several years ago for her daughter Chloe. Chloe’s birthday is 1 June.

15 May 2021 – pay £9,000 into the CTF
1 June 2021 – Chloe’s birthday, new CTF allowance
15 June 2021 – pay £9,000 into the CTF
1 July 2021 – transfer CTF to JISA
15 July 2021 – pay £9,000 into the JISA

A couple of pitfalls to note, however.

It’s not possible for a child to hold a CTF and JISA at the same time, so the CTF funding must happen before the transfer to the JISA. (If it were to happen after, the JISA would be declared void and funds returned.)

The registered contact (i.e. the parent or guardian responsible for the account) must be the same person on the CTF and the JISA otherwise the transfer cannot go through.

It is possible to change the registered contact without much difficulty, but clients will need to get their ducks in a row before executing the strategy.

Junior ISA to adult ISA transition – dual allowances

In September 2020, we saw the first CTFs come to maturity as the first cohort of CTF children turned 18. Many of these CTFs will be transferred into adult ISAs and will continue to grow tax-free.

The opportunity I want to talk about here, though, relates to JISAs and to children in the 16–18 age bracket.

The minimum age to open an adult stocks and shares ISA is 18. But from the age of 16, children can open an adult cash ISA, for which they have the full adult ISA allowance of £20,000 available to them.

They also still have the full JISA allowance of £9,000, given that the two accounts are separate tax wrappers. The £9,000 does not reduce the adult allowance in any way. Money can be paid into both accounts in the same tax year.

Example

Jenny also has a son Max. His birthday is 14 October. He has a JISA.

2021/22 tax year

6 April 2021 – pay £9,000 into the JISA
14 October 2021 – Max turns 16, pay £20,000 into an adult cash ISA

2022/23 tax year

6 April 2022 – pay £9,000 into the JISA
6 April 2022 – pay £20,000 into the adult cash ISA

2023/24 tax year

6 April 2023 – pay £9,000 into the JISA
14 October 2023 – Max turns 18, pay £20,000 into an adult stocks and shares ISA

Over three years, Jenny has paid £87,000 into Max’s ISAs – all tax-free – which is a lot more than Jenny could have paid into her own ISAs over the same period.

Max’s JISA converts to an adult ISA at age 18. Rather than maintain three accounts, he transfers the converted JISA and the cash ISA into his stocks and shares ISA, which continues to grow tax-free.

This article was previously published by Professional Paraplanner