Investing for children: Best ways to invest using Junior ISA's, Junior SIPP's and Bare Trusts
Introduction
In today's video, I want to share different ways in which parents, legal guardians and grandparents can invest in their children’s future. Usually, parents want an education fund or a helping hand fund for a house deposit, etc. And want to be smart about investing with tax efficiency.
Sometimes, grandparents give cash gifts which can also be beneficial for inheritance tax or children receive birthday money that can be invested in a smarter way than a cash account. If you want to also learn how to teach your children about the value of money, besides learning how to invest for them, then keep on watching. Oh, and I have some bonus tips about encouraging financially responsible habits with your children at the end.
Hi! I am Cleona, founder of Conscious Money. On this channel, I give you honest strategies around being free and clear with money.
What is important to you?
Before I jump into some of the ways you can use to invest like Junior ISA’s, Junior SIPPs or a Bare Trust, you need to pay attention to what is important to you and your values, for your children - so that you are clear on your motivation and purpose for this money. In other words, what do you want to see happen with the money? What is your reason for investing? I am asking you to focus on what intention triggers the action, your why. And also, what do you want to have happen for your child with the money, when your child turns 18.
For example, is it more important to help them with college or a house deposit when they are young adults, is it more important to have an accessible fund for the next few years for private school, is it also about teaching them how to be grounded around money, is it to help them understand financial principles like compounding and having patience while investing… Is It all of the above.. If so, which feels more priority… take some time to get clear on your purpose and goals before you decide.
Notice what feels lighter
And notice what feels more important - your body in fact will give you a clear response, when you listen to it, on what feels more yes or no… What option feels lighter.. As you watch this video. And notice what feels more important. Taking the time to clarify your goals and purpose will make the decision easier for you.
On to Wrappers
So, the wrappers more commonly used in my experience, are Junior ISAs, Junior Sipps and Bare Trusts. There are also other kinds of trusts, but for today's video, I will focus on these three.
Now, I asked some of my friends who are parents to help me with what they worry about or want to prioritise with investing for kids. One of them said, what do I do if I am not financially savvy. The best thing to do is to either talk to those who are and ask for support or build your own skills by reading, watching videos, listening to podcasts... it really is simple and not impossible for you to build financial literacy skills... Trust me, just go for it - with a little persistence and curiosity, you will learn. Or of course, pay for professional help, although I am more for learning yourself, if you can, especially with smaller amounts (because the cost of an Independent Financial Adviser is a fixed initial fee which may not justify the cost if it is a smaller amount).
Invest in the child’s name or the parent’s name?
The first question is usually - do we invest in the child’s name or as parents in our names? It depends on the age of the child, accessibility and if as a parent, you are willing to offer full control when the child turns 18. Quite often, parents invest small sums of money in the child’s name and larger amounts in their own name. For ex: investing £50 a month or so in the child’s name but larger inheritance sums like, let’s say £30,000 gifted by a grandparent in the parents name.
If the child is only three years old now, for example, how will you know when the child is old enough, mature enough to use it for the intended purpose? Some parents also joke that they don't want their kids to buy their first sports car at 18 or anything like that. So, if the answer to these two questions is no, often what parents do, in my experience, is they invest or save in their own name while earmarking them for their children. That way, it remains flexible in case of an emergency and a need for funds arises earlier.
Cons of doing it in a parent’s name
The con of doing it in your name, of course, as a parent is that it is now in your estate as a parent potentially for inheritance tax. Whereas if it is given to the grandchild and invested in their name, it bypasses going into your estate. Although, from what I have seen, it seems more important for most parents to have control and flexibility to access rather than worry about inheritance tax... The other disadvantage is that parents may be tempted to dip into the money sooner than planned.
If grandparents are gifting, they may want to do it earlier because of their tax situation and the impact of the inheritance tax. If money is needed more immediately, you can set up bank accounts to hold cash gifts for a child with parents acting as a nominee/signatory. But generally children cannot hold investments in OEICs/unit trusts or investment bonds.
Investing in the child’s name.
Children are taxed like adults, which is where it can get confusing. If a child has no income, they won’t be taxed. However, if the money saved for them generates more than £100 interest a year it will be taxed at the parent’s tax rate for all the interest – not just the bit that’s over the £100. This isn’t a big deal when interest rates are low, but it could have a material impact in the future, if interest rates change upwards.
JISA - Junior ISA
So, speaking from my experience, a Junior ISA held in the child's name is the most commonly used strategy for smaller amounts like birthday money or funds you can just leave to roll over for a while. If a grandparent gifts a large sum like £100,000 for example, then like I said, most parents tend to opt to invest it using their own ISA’s and investment accounts - just to have more control, access & flexibility.
Parents and grandparents and legal guardians may make a contribution to a Junior ISA. The annual subscription limit is currently £9,000 (2020/21). This annual limit is decided by the government each tax year. Having a JISA allows a pot of savings free from income tax and capital gains to be accumulated for the child or grandchild. You can have a cash ISA or a stocks & shares ISA but with interest rates so low, I would suggest the stocks and shares ISA route for better long term compounding.
If the annual subscription is paid each year from surplus income, the gifts may be immediately outside the estate for IHT.
You can also transfer child trust funds to Junior ISA’s. If a child was born between 2002 and 2011, they might have a Child Trust Fund (CTF). These can be transferred into a Junior ISA. Junior ISA’s have more investment fund choice, so are more attractive, I would say, than child trust funds. You can check online for providers that do this. Not every provider will take a CTF transfer to ISA but many do.
Pro’s of a JISA:
Can begin investing right away with a long-term view
No tax
Other family members and friends can be encouraged to make contributions into it and know it will benefit the child.
It’s a generous annual allowance
Cons:
The money belongs to the child who can take control of the account when they turn 16 and then start withdrawing money from the age of 18. They could buy a fast car but you would also have had many years to instill good financial habits in them and foster fiscal discipline to avoid this scenario.
When you put money into a Junior ISA, it is no longer yours, it is your child’s, and you will not be able to withdraw it again although you could transfer it to another type of JISA.
Now on to Junior pensions
Any parent or legal guardian can set up a pension, as soon as the baby is born, and it will automatically transfer to your child once they reach 18. They can then start contributing to it themselves.
Contributions can also be made by third parties into a child or grandchild’s pension. Of course, the disadvantage is that the child does not have access to the money before the minimum retirement age, which is now 55 and will likely continue to be revised upwards over the years. For me, this is also the beautiful part because it lends so beautifully to long-term compounding.
If the child has no earnings, then contributions will be limited to £2,880 a year, with the government automatically topping up any contribution with basic rate tax relief at 20%. So it gets grossed up to £3,600. However, higher contributions can be made if the child has earned income. Contribution limits and tax relief are based upon the child’s tax position.
Paying into an adult child’s pension
Paying contributions to an adult child’s pension is also possible, but make sure they fund their own pension if they get any employer matched contributions, you don’t want them reducing their own pension funding at work, because there is a gift. This receiving gifts into a pension can be extremely helpful for young families who may have pressures with large mortgages or rent, child care costs, etc.. And as they are likely to have earnings themselves, higher amounts up to the annual allowance can be gifted.
The gift to a child’s pension, whether they are a minor or adult, will be a potentially exempt transfer for IHT. This simply means it will be outside their estate should the donor of the gift survive for seven years from the date of the gift.
Even if you invested only £3,600 and left it for 55 years, if it grew at 8%, this would mean your child would have nearly £250,000 by age 55. 248,089.88 at age 55 to be exact.
Pro’s of a pension:
A generous boost with basic rate tax relief
The child can take control at age 18 but not access it till 55 so it is the ultimate long term investment
Can help teach the child early on about how pensions work
Huge head start at age 18 for compounding. Starting with a bigger snowball coming down the mountain is more effective.
You can contribute as little as £25 a month
Anyone can contribute
The educational value of teaching about pensions
Cons:
Funds cannot be used for a house deposit, etc.
No accessibility till age 57
They may thank you only at age 57! :)
Tax rules could change
Bare trust
This is the simplest kind of trust to set up. There are other types of trusts, but for this video, I will keep things simple and stick to the bare trust.
Mostly, grandparents set aside funds using bare trusts for their grandchildren’s education. If the funds are given away early and the grandparents survive seven years, then this gift will be outside the inheritance tax charge on their deaths.
A bare trust is a simple, legal document that anyone can set up. Assets (e.g. Investments) are held by a trustee (often a parent or grandparent) for the benefit of a beneficiary (usually a child). There is no limit on what or how much can be put into a bare trust.
If held in bare trust it allows the child’s own income tax (personal allowance, savings rate band, personal savings allowance and dividend allowance) and CGT allowances to be used. Yes, children have their own allowances too!
It’s easier to control for using up to the capital gains allowance by taking gains, but remember to read up on the rules on capital gains such as bed and breakfasting.
If you reinvest the sales proceeds and buy the same shares back within 30 days, for example, it cancels out the gain made.
The named beneficiary(ies) cannot be changed so if other children or grandchildren came along, you would set up another bare trust or trusts. Bare trusts can be inflexible.
The beneficiary (so the child in this case) has a right to both the capital in the trust and any income generated from it. If a beneficiary demands the trust property once they are 18*, the trustees must pay it to them. This is 16 in Scotland. The beneficiary is automatically and absolutely entitled to any money or investment remaining in the trust at the age of 18, hence why you wouldn’t use this method for large sums usually.
Pro’s:
Using the child’s tax allowances
Gifts into trusts will fall outside your estate for inheritance tax (IHT) purposes after seven years.
Useful when beneficiaries are minors
No tax returns needed if income/gains within allowances for the child.
Simple set up
Cons:
A beneficiary can take control at age 18.
If the child has a short life expectancy, the value of the trust assets is included in their estate, so if the child dies young and is intestate (which is most likely), there’s the potential for a substantial inheritance tax charge.
Means work for you as a trustee. For example, you have a duty to invest trust assets, and consider whether and how to use the trust’s income and capital for the beneficiary.
No tax advantages to parents gifting money via a bare trust.
Simple to open
It’s really simple to open these accounts - takes a few seconds and you will need your ID, National Insurance number and bank details to hand. When picking a provider, make sure you are aware of all the fees charged and that it is easy to use, technology wise. And of course, that it offers the investment choices and funds you want. Ultimately, these are investments so they do only as well as the underlying investment funds do. So, whether you want to invest in passive, active, managed funds or sustainable funds, make sure you are happy with the choice offered before you commit to the provider. The provider will usually be happy to answer factual questions if you call them; they won’t give you advice though.
Talking to children about money
As I talk to both parents and grown up children who are my clients, I can see a distinct difference between those who did get to learn about money at home and those who didn’t. Some families just don’t talk about money; or there is a lot of secrecy and conflict around who has the power, etc.
It is what it is; We all don’t have the perfect Disney family, however money skills are increasingly important to learn so if you can include your children in these conversations and talk to them about money in engaging, relatable ways - you will help them have a less dysfunctional relationship with money - potentially influencing a whole generation. Otherwise, we can pass on our unease about money. We want to be raising financially responsible kids so have open dialogues about money, listen to your children, encourage them to ask questions.
However small it is, encourage them to have some of their earnings towards investments.
Too many people start learning about money in their 30’s or later... so help them get a good education what the basics of investing are, how incredibly boring it is most of the time as you do nothing…
Bonus tip
My bonus tip is to set up both a pension for your children, you can do the minimum monthly investment for a year in the pension and then forget about it, let it compound.
When the child is around 8 or 9 years old, you can encourage them to look at their pension pot annually & add some money to it, which you can match. This way, you teach them about money, you can show them via an online investment calculator, some projections based on growth rates - so they can learn both about maths and compounding.
I don’t think most parents are excited about saving to help their kids retire and put large chunks of money in something they cannot even access... But when the decision is framed as helping them learn financial responsibility, I see parents’ eyes light up. Even a £1,000 in a pension just to accumulate in a fairly high equity portfolio (remember higher the equity, the higher the returns, longer the term) will give them a great head start.
Notes on inheritance tax:
Where a parent or grandparent makes a gift this will typically be either a PET (potentially exempt transfer) or CLT (chargeable lifetime transfer). This will be outside their estate should they survive for seven years from the date of the gift.
However, certain ‘gifts’ may be immediately exempt, or just not regarded as transfers at all.
Payments by a parent towards their child’s maintenance or education are not regarded as transfers of value and are therefore free from IHT. The child must be under 18 or in full-time education to qualify. This treatment does not apply to similar payments from grandparents. These would normally be treated as gifts, and therefore either PETs if made directly or to a bare trust, or CLTs if made via a discretionary trust.
Normal expenditure out of income. Regular gifts which are made from surplus income and do not affect the donor’s usual standard of living are immediately exempt.
Annual exemption. Up to £3,000 can be gifted each year IHT free. If the previous year's allowance has not been used, this can be carried forward to make £6,000.
Small gifts. Any number of small gifts of up to £250 can be gifted each year.
Gifts in consideration of marriage. Each parent may gift up to £5,000 in consideration of marriage or civil partnership. For grandparents the figure is £2,500.
Source: Standard Life
On savings:
Friendly Society tax-exempt plans and NS&I Premium bonds are also avenues for savings.