Tax Doctor: How to make the most of tax wrappers for children

The case

Grace has recently come into a large inheritance and she wants to invest as much of it as possible for her children. It’s important that both children are financially independent in the future and therefore she wants to get their investments off to a flying start.

She has a daughter who has just turned 16 and a son who will be turning 14 next March. Grace has previously opened a child trust fund (CTF) for each child and would like to use her lump sum to maximise the amount she can invest tax-free for them during the next few tax years.

Her daughter’s CTF was transferred to her junior ISA in full during the last tax year. Her son currently only has a CTF.

The diagnosis

A junior ISA can be opened for a child up until their 18th birthday. The subscription allowance is £9,000 per tax year.

As soon as they turn 18, the child can also open an adult stocks and shares ISA and start taking advantage of the £20,000 adult subscription allowance.

However, it’s worth remembering they can open an adult cash ISA from their 16th birthday. And because it’s an adult ISA, it gets the full adult allowance of £20,000. What’s more, a child can hold an adult cash ISA alongside a junior ISA while they are under 18 and have money paid into both at the same time.

This means a total of £29,000 can be paid into their ISAs in a single tax year. This can be repeated in the tax years they turn 17 and 18, meaning total tax-free savings of £87,000 in less than three years.

While CTFs were closed to new applications in 2011, there were still a staggering six million of them in April 2020. Meanwhile, in 2015, the transfer rules were relaxed to allow parents to transfer CTFs to junior ISAs, and many clients have taken advantage of this.

Like junior ISAs, CTFs have an annual allowance of £9,000. Unlike junior ISAs, however, the CTF allowance starts on the child’s birthday rather than on 6 April. This means it’s possible to pay in a total of £27,000 in a very short period around the child’s birthday.

This consists of two payments of £9,000 to the CTF, then a payment of £9,000 to the junior ISA once it’s transferred, as the junior ISA allowance is separate from the CTF allowance.

The prescription

For her daughter, Grace can make the most of being able to invest up to £29,000 in each of the next three tax years by following the below steps, meaning her daughter could be left with a tax-free pot worth £87,000 before even factoring in any investment returns.

Tax year 1

• Pay £9,000 into junior ISA
• Pay £20,000 into adult cash ISA (after child turns 16)

Tax year 2

• Pay £9,000 into junior ISA
• Pay £20,000 into adult cash ISA

Tax year 3

• Pay £9,000 into junior ISA
• Pay £20,000 into adult cash ISA or adult stocks and shares ISA (after child turns 18)

For her son, Grace should follow the below few steps once he reaches his 14th birthday. He can also then benefit from the same scenario as his sister once he turns 16.

1. Pay £9,000 into the CTF

– Child’s birthday –

2. Pay £9,000 into the CTF

– Transfer CTF to junior ISA –

3. Pay £9,000 into the junior ISA

A small word of caution. With this opportunity, it’s important the payments go to the CTF first and the CTF is transferred in full, as it’s not permitted to pay into a CTF and a junior ISA at the same time.