Money: Saving for children isn’t kids’ stuff

IT HAS been a while coming, but on 1 November the replacement for the doomed child trust fund (CTF) will be finally open for business to those wanting to invest in their children’s future.

The Junior Isa (Jisa) is not a direct substitute for CTFs, which were closed to new business at the start of this year, as it offers the tax benefits of the latter but without government contributions.

While the CTF scheme was aimed at encouraging lower and middle-income families to save for their children’s future with government assistance, the new regime is likely to be adopted as another tax planning tool for the more affluent.

From 1 November, the Jisa will be available for children under the age of 18 who do not have a CTF account (eg they were born before 1 September, 2002, or after 2 January, 2011). They will operate in the same way as adult Isas by providing tax-free savings on capital gains and investment income (although the 10 per cent tax credit on dividends cannot be recovered).

The Jisa allows contributions – normally by a parent or grandparent – of up to £3,600 a year (also the revised limit for existing CTFs). This will be the Jisa limit until April 2013, after which it will rise annually in line with the Consumer Prices Index (CPI) measure of inflation.

The contributions can be invested in cash funds or “stocks and shares”. It is important to note that, unlike an adult Isa where withdrawals are permissible, withdrawals from a Jisa before the child reaches age 18 are not permissible unless the child is terminally ill.

This means that the Jisa is best used as a way of long-term saving, such as for university costs or helping a child take their first step on the property ladder. However, the child can become responsible for the account from the age of 16, so it is important to ensure they understand the complexities and financial impact of any investment decisions.

A key advantage for parents is that, unlike most other child investments they can make, the income generated will not be taxable on the parent even if it exceeds the £100 a year threshold.

Each child will be able to have one cash and one stocks and shares Jisa at any one time. The Jisa will change into a normal Isa when the child reaches age 18, so the tax advantages of these investments can continue.

Don’t underestimate the extent to which the fund can add up over a few years of contributions.

A Jisa could provide a tax-free gift of approximately £106,340 at the age of 18, assuming the child’s parents invest the maximum £3,600 each year from birth and also assuming a 5 per cent a year investment return.

But Jisas aren’t the only investment schemes aimed at those saving on behalf of a child or grandchild. For example, where regular payments are to be made, the following options are available:

n A parental Isa allows investment of up to £10,680 per individual in their own name (including £5,340 in cash), while maintaining overall control of the investments even after the child is aged 18;

• Growth-oriented collective investments in open-ended investment companies (OEICs) and unit trusts, with a focus on growth to make use of capital gains tax (CGT) allowances (currently £10,600) to provide an income stream or lump sums in the future;

• National Savings & Investment (NS&I) children’s bonus bonds allow an investment of up to £3,000 per issue, with a tax-free return which is enhanced with a bonus if held for the five-year term. Premium bonds allow maximum investments of £30,000 and provide tax-free returns if you win on the monthly prize draw;

• Qualifying savings policies (Maximum Investment Plans) provide proceeds that are completely tax-free at maturity. However, these are not easily accessible before the expiry of ten years and there are relatively few providers;

• Regular savings accounts pay up to 4.5 per cent a year, and any interest can be paid gross (using the HMRC R85 form), provided the total income does not exceed the child’s £7,475 allowance. However, any interest over £100 a year would be taxable on the parent.

If you would rather make lump-sum investments for a child or grandchild, the following options are available:

• Investment bonds provide a tax-efficient environment for investment, with the ability to assign segments of the bond (onshore or offshore) to the child once they reach age 18 (although this will probably result in a chargeable gain for the settlor);

• Collective investments allow you to use the annual CGT allowance;

• A bare trust (child has absolute entitlement at 18) could result in tax advantages through investments in unit trusts and OEICs using the grandchild’s CGT allowance or an investment bond, where any chargeable events would be applied to the grandchild;

• A discretionary trust allows control to be maintained and for trustees to determine who should benefit, which could be useful if further grandchildren are born. Investment options include bonds and collectives.

Overall, the introduction of Jisas is a welcome addition to long-term financial planning for children, as it offers good flexibility in terms of investment choice along with the tax advantages.

However, there are clear disadvantages when compared with parental Isas The Jisa does not allow withdrawals before the child turns 18 and also lacks the control of parental Isas, as it passes completely to the child at age 18, when they may not be mature enough to receive a large sum of money.

It is also likely that Jisas will be the preserve of better-off families who have already maximised the use of their own Isa allowances (£21,360 for a married couple), which is less likely to be possible for lower to middle-income families.

The complexity of such investments means it is important to get the best advice possible to assess the most suitable investment option based on your circumstances.

• James Glass is a chartered financial planning consultant with PKF Financial Planning