The main aim of investing for a child is usually to provide a nest egg to help them out financially in later life. However, there are additional benefits that could see the amount of tax needing to be paid both now and in future reduce significantly.
As with all things tax the rules are likely to change over time. The benefits will depend on the individual circumstances of the child and the person paying into the child’s account.
The simplest way to minimise tax is to use a tax-efficient account such as a Junior ISA or child’s pension such as the Junior SIPP. As the investments are held in the name of the child, no tax liability falls on parents either.
Investments outside a Junior ISA or SIPP are liable for tax. One solution is a legal arrangement called a bare trust, which we offer through our Junior Investment Account. The investments are not held in the name of the child, but are taxed as if they belong to them - it is therefore necessary to consider the tax position of the child and also the person who is adding money to the account (the donor).
When money or assets are paid into an account (including Junior ISAs, Junior SIPPs and Junior Investment Accounts) for someone else's benefit, they are treated as a gift. Some gifts are free or exempt from tax, others may be subject to inheritance tax (IHT).
You can normally give away up to £3,000 per tax year inheritance tax free. This is known as the annual exemption. If you haven't used your annual exemption in the previous tax year you can carry it over into the next tax year, but if you don't use it in that year, the carried-over exemption expires.
For example: if you used £2,000 of your annual exemption allowance in the last tax year you could then gift £3,000 for the current tax year, and £1,000 carried over, a total of £4,000.
On top of the annual exemption is a small gifts exemption. This allows you to give up to £250 each to any number of recipients each tax year, although not to anyone who received a gift from any other exemption. Please also bear in mind that you can't give more than £250 and claim the first £250 is a small gift. If you give an amount greater than £250 the exemption is lost altogether.
You can also make 'gifts out of income' free from inheritance tax. Regular payments made out of excess income (which don't affect your standard of living) are normally exempt from IHT. This can be a useful exemption for those wanting to contribute to a child’s investments through regular savings.
If you make gifts over and above exemptions, they may still be free from inheritance tax providing you survive seven years from the date of the gift. These are known as potentially exempt transfers.
Keeping a record of any gifts you make and noting which exemption you've used will make administering your estate easier when you die.
If you make regular gifts out of income as part of your normal expenditure you should keep a record of your after-tax income. These records should be used to demonstrate the gifts you've made are regular and you have enough income to cover them and your usual day-to-day expenditure, without having to draw on your capital.