Wealth Planning in focus
Saving for the next Generation
Anthony McManus, Wealth Planning Assistant
Adi Kuznicki, Illustration
If anything, other than the myriad of struggles Coronavirus has brought upon society, it has awoken the painful ignorance in a vast number of young people towards saving not only for their future, but also for immediate emergencies.
For the millennial generation, the ‘Bank of Mum and Dad’ has acted as a last chance federal reserve to ensure they can continue to live through their blind profligacy. In the wake of the Covid-19 pandemic, the ‘Bank’ has now extended its services, providing bed and board for many.
I may hyperbolise slightly, but Covid-19 has highlighted the need to start saving early for our children to ensure they are in a more secure financial position come the need to pay for studies, afford a first home or be prepared for immediate financial emergencies.
Research would suggest that it is family who act as the greatest influence on their children’s saving habits.
When it comes to our children saving for themselves, certain behaviours affect their motivation, not least the rising cost of living having made it difficult to put money aside. Young people’s spending and saving priorities also differ from past generations, as they feel more pressured to take on debt and spend more.
Research would suggest that it is ordinarily family who act as the greatest influence on their children’s saving habits. Parents can ingrain good habits from a very young age and are the main source of financial advice for young adults.
With regards to providing your children with a greater financial foundation, Child Trust Funds (CTFs) were a wrapper offered between 2002 and 2011 offering tax-free savings accounts for children under the age of 18. Since 2011, CTFs have been replaced by Junior ISAs (JISA), which carry similar traits with an increased and generous annual allowance of £9,000 for this tax year. Parents are the only ones who can actually open a junior ISA for a child, but family members like grandparents can pay money into the account.
Contributing to a JISA can be used as a tactic to reduce your future inheritance tax liability. Making gifts is a good way to reduce the value of one’s estate and to benefit the ones closest to you. Regular contributions (i.e. monthly) to a JISA for a child or grandchild can be exempt from inheritance tax, as long as they are gifts out of income and do not affect your lifestyle. Alternatively, if a regular payment is not an option, gifts to Junior ISAs by using your whole £3,000 annual gift exemption will not be liable to inheritance tax.
Given the JISA allowance is £9,000, if you are generous you may exceed your £3,000 exemption, for which the additional gifts will be classed as Potentially Exempt Transfers (PETs) for inheritance tax purposes. If you died within seven years of each annual gift, it would still be counted as part of your estate and may be liable to inheritance tax.
Junior ISAs are available for any child under 18 who doesn’t already have a Child Trust Fund. As a parent or guardian, a JISA is a long term, tax free way to invest in your child’s future. The parent or guardian will contribute to the account but only the child can access the money – and only after they turn 18. The good news is that Child Trust Funds can now be converted to JISAs.
Of course, you can open a JISA at any time before your child reaches age 18, but it is considered smart to open a JISA from the day they are born. The full 18 years means they can benefit from compounding and afford to take greater investment risk. With tax-free interest on the income and capital gains, the money you invest could grow even faster. It allows parents to lay the foundations for their child’s financial future by granting long-term tax-free savings or investments. Ordinarily, should a parent invest or save money for their child using a different investment wrapper, any interest earned on savings in excess of £100 would be taxed at the parents’ marginal rate of tax.
JISAs are a tax-efficient way of passing money on to children, particularly if the parent has already used their own adult ISA allowance of £20,000 for the tax year. The tax exemption for income and growth on JISAs is helpful where parents have no tax-free savings allowances of their own and would otherwise be taxed on the savings.
Given the age required to open an Adult Cash ISA is only 16, many people are not aware that a 16/17 year old can utilise not only their annual JISA allowance of £9,000 per annum, but they are also entitled to utilise an adult cash ISA allowance of £20,000, increasing their overall annual ISA allowance to £29,000. Note that one cannot open an Adult Stocks & Shares ISA until they reach age 18.
When I began this article I, possibly quite harshly, alluded to the liberal spending of children. With this in mind, a potential disadvantage for JISAs is that, ultimately, your child has the say on how to spend the funds. You should be aware that your child can take control of the account when they turn 16 and start withdrawing money from the age of 18. As a parent, you may have opened the JISA with the aim to pay off your child’s university fees, but when your child turns 18, they may have other ideas.
A way to ensure your child uses the money saved sensibly is to educate them on finance and get them engaged in the decision making about how it is invested early on in the investment process. The JISA can be used as an opportunity to engage with and educate children on the importance of long term saving and investing.
Grandparent Bare Trusts
Bare Trusts are often used by grandparents who wish to provide for a grandchild (or grandchildren) who is/are too young to accept and invest a gift. Note that even though grandparents are used as an example, the provider of the property (i.e. investment) for a bare trust can be anyone including aunts, uncles and friends of the family.
A grandparent may open a savings account in the name of their grandchild and transfer cash into the account. The monies belong to the grandchild but the grandparents would retain signatory powers and if appropriate might withdraw the funds to be used for the benefit of the grandchild (e.g. payment of school fees).
With regards to the tax treatment of the trust, the beneficiary (i.e. the grandchild) is treated as the beneficial owner of the property held – not the trustees. As such, any capital gains arising within the trust are those of the beneficiary who is entitled to the current annual CGT exemption of £12,300. Likewise, as the transferor of property is not a parent but is a grandparent, for income tax purposes the income is that of the grandchildren, who can use their own personal allowance of £12,500.
As is the case with a JISA, on attaining age 18 the beneficiary of the trust (i.e. grandchild), can demand access to the trust property and any income that has been accrued. It is this aspect of a Bare Trust that is often considered a disadvantage as, at times the sums invested can be quite substantial, and effectively too significant for a cash-hungry adolescent.
As a secure, 100% safe HM Treasury backed savings investment, Premium Bonds are often considered an attractive investment for your children. Premium Bonds can be purchased on behalf of children under the age of 16 and bought as gifts, as the purchaser nominates one of the child’s parents to look after the bonds until the child turns 16 years old. Any prizes won and any payment for cashed-in bonds will be sent to the nominated parent, or the prizes will be paid to the child’s premium bonds account if elected.
The potential to win a tax- free sum of between £25 and £1million in a monthly prize draw is incredibly attractive, but unlike other savings vehicles, premium bonds do not pay interest. This means the investment will gradually lose its value against inflation each year. As is the case with any lottery, the more Premium Bonds you buy, the greater your chances of winning. The issuer of Premium Bonds – NS&I – note that the average savings ‘interest rate’ would be 1.4% after regular ‘wins’ on the monthly prize draw. Nevertheless, you are not guaranteed to win, as the odds of winning for each £1 of bond purchased are 24,500 to one.
As a comparator, should your child’s Premium Bonds ‘win’ regularly and attain an interest rate of 1.4%, this is still dwarfed by cash JISA interest rates that can currently exceed 3.00% from some providers. NS&I even offer a JISA with a top rate of 3.25%. When investing for young children, the term of investment is long so you may prefer to consider investing in the stock market than cash, to try and beat inflation.
A variety of investment vehicles exist to help parents save on behalf of their children to provide them with the best financial foundation in adulthood. Nevertheless, it is of equal importance to educate your children on saving for the future, or you can expect your children to be a more frequent customer of the ‘Bank of Mum and Dad’ for years to come!
To arrange to speak with one of our Chartered Financial Planners to discuss investing for future generations and learn how JM Finn can help, please contact your investment manager.
The information provided in this article is of a general nature. It is not a substitute for specific advice with regard to your own circumstances.