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Investing for children

Date: 23 November 2020

Who is this article for?

Advisers seeking information on the most effective ways families can save for their children.

Key takeaways

Like a horror film, investing for a child can be a scary experience. When should parents start? How much should parents save? Can parents control when the child accesses the money and importantly what they spend it on? Depending on the investment vehicle chosen, some of these questions answer themselves but there are choices and each should be considered.

 

Junior ISAs are a key savings vehicle

One option often taken by parents when saving for their children is a Junior ISA (and their predecessor the Child Trust Fund). Under Junior ISA rules, when a child reaches age 18, the Junior ISA becomes an adult ISA, and the child gains control over how the money is spent.

We estimate that parents investing the maximum contribution each year into a stocks and shares Junior ISA for 18 years could save around £330,000 (assuming the allowance increases 2% a year and investments grow by 4% net of charges). That’s a lot of money to give an 18-year-old!

A Junior ISA is a simple choice but probably (for most anyway) the contribution is likely to be much smaller than the £9,000 annual allowance. The Junior ISA offers tax efficient growth and has the benefit of ‘rolling’ into an ISA. The child can then access tax free capital as and when they choose after 18 and could retain some or all of the investment in a tax wrapper for years to come. In common with the adult stocks and shares ISA the value of the investment can fall as well as rise and investors may not get back the amount invested.

 

60% will be accessed at 181

Every child is different and a parent’s attitude towards their child receiving a lump sum of money on their 18th birthday ranges significantly. The main investment vehicle (discussed above) is currently the Junior ISA or JISA which superseded the Child Trust Fund (CTF) in 2011. With the first CTFs (starting in 2002)  beginning to mature, the worry for parents is fast approaching – when will the money be spent and what their children will spend it on.

60% of parents believe their children will access their Child Trust Fund at 18, and 85% said they think their children will have accessed it by 211. Spending the money on a car tops the list followed by education costs and entertainment in 3rd place1.

With so many children accessing their savings at 18 what are the alternatives and how tax efficient can they be?

 

Using an adult ISA limit provides control

Parents can retain more control by investing into their own ISA either exclusively or after they have contributed an amount to the Junior ISA that they are comfortable with. Contributions made into an ISA in the parent’s name can still be used to fund the child’s future, but the parent would retain control over when and how the money is spent.

The downside of this approach is that the savings for the child uses the parent’s own tax-sheltered allowance. Depending on wealth, the current £20,000 ISA limit may provide sufficient room for both personal savings and that earmarked for the child but for parents who already maximise their own ISA allowance another alternative solution might be required.

 

Offshore bonds can provide a less obvious solution

Similar to an ISA, investments within an offshore bond will grow tax-free and are not subject to capital gains tax. This is because, unlike UK insurers, offshore insurers do not pay any corporation tax on policyholder funds. There is also no limit to the savings unlike the Junior ISA and ISA. The value of the investment can fall as well as rise and investors may not get back the amount invested.

Offshore bonds allow 5% of the initial premium to be withdrawn each year, which is tax-deferred so there is no immediate tax to pay. These can accumulate over the years to provide access to future cash lump sums for the child as and when required.

Alternatively, as an offshore bond is divided into lots of segments, parents will have the added flexibility of being able to assign individual policy segments to their child as and when required (once the child reaches 18). Assigning policy segments means ownership and control can pass to the child with the added advantage of not having to disinvest the money first.

Provided the child is a non-taxpayer there could be no tax to pay when money is withdrawn (provided the growth on the segments assigned is below the child’s personal allowances). The child could also benefit from any accumulated 5% withdrawals on the segments assigned as mentioned above.

This provides parents with flexibility and control over when their child accesses the money without impacting their own savings allowances whilst providing parents with the flexibility to leave the money invested for the longer term, or use the money for something else altogether.

The use of an offshore bond in saving for children is discussed further in this case study.

Mix it up

To avoid a scary 18 certificate, the likely answer to this problem is a mixture of all of these investment vehicles, particularly for wealthier families looking to provide a more significant savings pot. A Junior ISA is usually the first point of call but with a limit to the savings and immediate access at 18 this might only be the first part of the solution. This could then be supplemented by using personal ISA allowances where available and/or an offshore bond for the rest. This would provide a well-rounded long-term savings plan providing some access at 18 with the rest following when considered appropriate by the parent.

1 Quilter survey August 2020 – 713 respondents

The information provided in this article is not intended to offer advice.

It is based on Quilter's interpretation of the relevant law and is correct at the date shown. While we believe this interpretation to be correct, we cannot guarantee it. Quilter cannot accept any responsibility for any action taken or refrained from being taken as a result of the information contained in this article.