Maximising investments for children and grandchildren

Did you know that, according to HM Revenue and Customs, more than 10,000 children already have pension plans in
place?

If you consider that there were more
than 900,000 Junior ISAs subscribed to in the 2017/18 tax year, then it’s clear
that many parents and grandparents are planning for their child’s future using
these investments.

Paying into your child or grandchild’s pension or ISA can
be an excellent way of helping them to build up a lump sum – and there are tax
benefits too. Keep reading to find out how you can maximise your child or
grandchild’s savings through a pension or ISA.

Paying into pensions for young children

If your child or grandchild is under the age of 18 you
can still contribute to a pension for them.

You can pay in up to £2,880 a year into the pension of an
under 18-year-old, and as the government still applies a 20% tax relief (even
though the child is unlikely to be working), £3,600 will be paid into the
pension each year.

When the child reaches the age of 18 they can continue to
make contributions to the fund.

One of the main advantages of paying into a child’s
pension is that there is huge compound growth potential. As the money may be
accumulating for 30/40 years or more, there is excellent scope for long-term
growth.

Of course, this is also one of the disadvantages. As the
child won’t be able to draw their pension until they reach retirement age (currently
age 55 with a plan to raise this to age 57 in 2028) the money is committed for
decades. The child could not, for example, use the cash to pay for higher education
or to fund the deposit on their first home.

An added bonus of paying into a
child’s pension is that you can potentially limit your future Inheritance Tax
liability. Gifts to a child’s pension are often covered by one of the tax’s
exemptions – for example, by the ‘gifts from surplus income’ exemption as long
as you make these payments regularly and they don’t affect your own standard of
living.

Paying into pensions for working age children

You don’t have to stop paying into a child or
grandchild’s pension when they reach the age of 18.

A feature of the pensions system is that a contribution by a parent is treated as if it had been made by the recipient. So, paying into your working age child’s pension has three potential tax advantages:’

Basic tax relief

If you pay £400 into your child’s pension, they will
receive basic rate tax relief on their contribution, meaning that £500 will be
invested.

Higher rate tax relief

If your child is a higher rate taxpayer, they can claim
higher rate relief on the contribution that you have made.

Your child/grandchild does this through the annual tax
return process, and it increases the amount of tax relief the recipient of the
contribution benefits from.

Child Benefit charge

If your child or grandchild is affected by the
high-income Child Benefit charge and earns between £50,000 and £60,000 (or
slightly above) the money you contribute is deducted from their income before
the high-income Child Benefit charge is calculated.

For example, if your child is earning £60,000 (and
therefore faces a Child Benefit tax charge of 100% of their Child Benefit
amount), your pension contribution of £8,000 (grossed up to £10,000 by tax
relief) would reduce your child’s income to £50,000 for purposes of Child Benefit.
It would have the effect of eliminating the tax charge.

Steve Webb, Director of Policy at Royal London says: “Not
every parent has spare cash to pay into their children’s pensions, but many
will be in a better financial position than their children can expect to
enjoy. By paying into their children’s pension they can give them a triple
boost and improve their long-term financial security”.

Paying into your child’s ISA

Almost a million Junior ISAs were subscribed to in the
2017/18 tax year, with around 57% of the money
saved in cash and 43% invested in stocks and shares accounts.

When you open a Junior ISA, you manage
the account and hold it on behalf of the child until they turn 18. In the
2019/20 tax year, you can save up to £4,368 in a Junior ISA tax-free – equivalent
to £364 a month, or just over £12 a day.

According to research from Which?,
if you were to take out a medium-risk stocks and shares Junior ISA, contribute £364
a month for 18 years, and pay 0.75% a year in fees, the investment could be
worth £111,000 by the time your child reaches 18. You would have contributed £78,624
over that time and receive £32,706 in investment growth.

Note that this growth is not guaranteed
and the money you deposit is at risk. You may not get back as much money as you
paid in.

In addition to the Junior ISA, if your child is aged 16 or 17 then you can also
contribute to an adult ISA in their name. This means you could save/invest
£24,368 in your 16 or 17-year-old child’s name, tax-free, before 6 April 2020.