Investing For Kids: Tax Efficient Vehicles & Investments For Parents, Grandparents of Anyone Else Who Wants To Start Building a Nest Egg For A Child
We all know that time is an investment portfolio’s best friend, which means investing for kids from an early age can build up a great financial foundation by the time they are ready to go off study or buy their first home. An investment portfolio set up for a child could even fund their distant retirement by the time that now far-off moment finally arrives. It can also be a great opportunity to get youngsters thinking about savings, investment and their personal finances from an early age and developing an understanding of basic principles.
There are also specialist cash savings products designed for children. However, with a long horizon of at least 18 years if an investment account is opened for a new born, and interest rates currently running well below inflation and with little sign of them rising significantly any time soon, there is a high chance that choosing investments rather than cash will result in a considerably higher cash value by the time they are drawn down. Investment professionals also tend to say that investments made with a longer time horizon can afford to be a little riskier and chase higher returns. That’s because there should be enough time for the portfolio to ride out any negative market volatility, which tends to have a greater impact on ‘racier’ assets.
As an added bonus, for those who have already used up annual ISA and SIPP allowances, there are also tax efficient savings and investment wrappers and investments that can be made on behalf of children. These can offer additional tax refuge for higher earners on top of their own personal allowances.
And while some investing on behalf of a child may have concerns around how responsible the future young adult will be when they turn 18 and have access to savings and investments made on their behalf as minors, Morningstar states that research shows very few teens actually choose to access that money. Or at least not for frivolous purposes. Youngsters who have been involved in the processes of an investment account being set up and monitoring its performance are also reportedly more likely to continue to invest their own money and from a younger age.
Let’s run through the main options available when it comes to investing for kids and what tax or other advantages they come with.
Probably the most popular option for those who want to invest on behalf of a child is the Junior ISA wrapper. Like the standard adult ISA wrapper, Junior ISAs come in both cash and investment formats so if you do want to invest through the ISA make sure the one you choose allows that.
A total of £902 million was put into Junior ISAs over the 2017/18 tax year by adults investing for kids. 48% of that was invested rather than saved as cash. Junior ISAs allow parents or grandparents an additional annual ISA allowance of up to £4386 to be put aside on behalf of young relatives. However, each child is allowed up to a maximum of two Junior ISAs per year – one investment JISA and one cash JISA. So not every parent or grandparent can, theoretically, open a different Junior ISA on behalf of the same child. Though while only parents and grandparents are allowed to open a JISA, anyone can then put funds into it.
As an added bonus, between the ages of 16 and 18, Junior ISA holders can concurrently hold both JISAs and their own standard adult ISAs, offering two years of extra ISA allowance.
Child Trust Funds
The first thing to make clear about Child Trust Funds (CTFs) is that they no longer exist. However, with 6 million CTFs set up and never claimed of transferred to a Junior ISA, which was made possible in 2015 after the scheme was abandoned in 2011, they are worth mentioning for anyone who wants to invest for an older child. CTFs were launched in 2005 as a means to encourage parents to start saving for their children from birth. CTFs received a £250 government bonus when a child was born and another £250 on their seventh birthday.
So a good first step is to make sure a CTF that could have a minimum £500 in it transferable into a Junior ISA doesn’t already exist in a child’s name. If it does, existing accounts do remain open and can still be paid into up to the same allowance as a JISA benefits from.
A Child SIPP is a savings and investment wrapper that can be taken advantage of by parents who are concerned about the future of pension provisions and want, from the very beginning of life, to help set their child or children up for a comfortable retirement. Child SIPPs come with an allowance of £3600 that can be taken advantage of in addition to a parent’s SIPP allowance and still benefit from 20% tax relief. That means that an annual investment of £3600 actually becomes £4320 when the government top-up is added.
18 annual payments of £3600, topped up to £4320 by tax relief and left to accumulate compound returns, if calculated at an average 5% per annum, would mean your child reaching the age of 65 with a pension pot worth well over £1 million.
Like an adult SIPP, a Child SIPP cannot be accessed until the holder reaches the age of 55, so there is also no danger of funds being squandered while the child is a young adult.
Trusts are an alternative to a JISA or Child SIPP and, unlike in the case of the former, a trust doesn’t have to be set up by a child’s parent or grandparent. Anyone can set up a trust to invest on behalf of a child. Trusts are also far more flexible than either a Junior ISA or SIPP and can hold most kinds of assets, from traditional asset classes such as shares, funds and bonds to property or even antiques or other collectibles.
There are two forms of trusts that can be set up for a child – bare trusts and discretionary trusts. In the case of a bare trust, when a child reaches the age of 18, the trust, and all assets it holds become accessible. A discretionary trust, on the other hand, appoints trustees who decide when and how much can be paid out to the beneficiary.
A further option to invest on behalf of a child is through the EIS or SEIS schemes. Both the Enterprise Investment and Seed Enterprise Investment schemes were initiated to encourage private investment in promising young business ventures, or startups, and are very generous indeed, reflecting the high-risk nature of this type of investment. However, investing through EIS or SEIS takes a huge chunk out of the capital actually being put on the line by the investor by allowing them to reclaim a whack of it back. This comes initially in the form of income tax credit and in further loss relief if the investment does not prove to be successful.
When investing through EIS, investors can claim income tax relief of 30% on investments in qualified young companies of up to an annual value of £1 million and no minimum level. In the case of SEIS, which companies in their very initial stages qualify for, income tax relief of 50% can be claimed on the investment. In the case of both EIS and SEIS investments, the remaining capital at risk also qualifies for 45% ‘loss relief’ against income tax if the investment is not successful. This means that £10,000 invested in an EIS-qualified startup only actually puts £3850 of the investment at risk and £2750 in the case of a similar £10,000 SEIS investment.
A further bonus is that shares from an EIS or SEIS investment disposed of for a profit at least 3 years after the initial investment are not subject to Capital Gains Tax. If the company goes big, or just does reasonably well, that could be a massive tax break.
Because up to £4 million can be invested through EIS and SEIS over any single tax year, these schemes could be an attractive investment opportunity for high net worth individuals who want to invest on behalf of kids. The fact that this kind of investment is by nature long term and illiquid also ties into the longer time horizons of investments made for children. And because Capital Gains Tax is not applicable to EIS and SEIS-qualifying shares, there are no tax implications to transferring this kind of investment into a child’s name as long as at least 3 years have passed since they were acquired.
Please remember that financial investments may rise or fall and past performance does not guarantee future performance in respect of income or capital growth; you may not get back the amount you invested.
There is no obligation to purchase anything but, if you decide to do so, you are strongly advised to consult a professional adviser before making any investment decisions.