These shelters keep the taxman away from your child's cash, shares and other gifts!
One of the most valuable lessons parents can teach their children is how to build a brighter future through saving and investing.
As Churchill once said: "Saving is a fine thing. Especially when your parents have done it for you."
Beware of the taxman
However, parents and other relatives need to proceed with care when giving financial gifts to children. This is because the taxman is waiting in the wings to seize his share of any income and profits.
A child has the same income-tax allowance as an adult (£7,475 in the 2011/12 tax year). However, if a child earns more than £100 a year in income from capital given to him/her by a parent (£200 for both parents), then this income is taxed as if it were the parent's.
However, this does not apply to income generated from gifts given by other relatives and friends, including grandparents, godparents, uncles and aunts, and so on. Usually, this income falls well within a child's tax-free allowance and, therefore, no tax is normally due.
Thus, it makes sense to have separate savings accounts for children: one for cash gifts from parents, and a second to hold money from other donors.
Tax havens for the under-18s
Of course, the best way to keep the taxman's hands off a child's assets is to make full use of one or more government-approved tax shelters. Here are three of the most popular tax havens for young Brits:
1. Child Trust Fund
A Child Trust Fund (CTF) is a long-term, tax-free savings account for children born between 1 September 2002 and 2 January 2011. Inside a CTF, a child can own cash or other financial assets such as shares, stock-market funds, bonds, etc.
Parents, other relatives and friends can pay in up to £3,600 a year into a CTF, but money can't be removed from a CTF until a child reaches 18. All income and gains made inside CTFs are completely free of tax.
When CTFs were launched in January 2005, our nation's finances were in much better health than they are today. As a result, every child born on or after 1 September 2002 got a CTF voucher for £250, with another £250 given to each child from low-income families. In addition, the government paid in another £250 (or £500) as each child turned seven.
Alas, thanks to the deterioration of the UK's finances, the £250 top-up CTF payments for seven year-olds ceased on 1 August 2010, with the £250 payments for newborns ending on 1 January 2011.
From 1 November 2011, CTFs were replaced by Junior ISAs (see below). At the same time, the yearly contribution limit for CTFs was increased from £1,200 to £3,600, so as to match Junior ISAs.
2. Junior ISAs
Just as any British adult can have an ISA (Individual Savings Account), their offspring can have a Junior ISA (JISA). Any child born on or after 3 January 2011, as well as all under-18s without CTFs, can open Junior ISAs.
Introduced on 1 November 2011, JISAs have a yearly deposit limit of £3,600, to match the newly up-rated CTFs. Like CTFs, JISAs can be converted into adult ISAs when a child reaches 18 (for JISAs, this happens automatically). Again, like ISAs, JISAs fall into two broad categories: cash accounts and stocks and shares ISAs.
However, there is one big difference between adult ISAs and Junior ISAs.
Adults can open a new cash and/or stocks and shares ISA each tax year with a different provider. However, a child can have only one cash JISA and one stocks and shares JISA, so parents should choose these providers carefully. Then again, as with ISAs, transfers between JISA providers are allowed, so switching to a better-value JISA account is possible.
Also, JISAs allow transfers from stocks and shares JISAs to cash JISAs, which cannot be done with adult ISAs. As an added bonus, a child reaching 16 can also open a cash ISA and, when 18, can have a stocks and shares ISA, too. Thus, a smart 18 year old could have several different ISA accounts.
In short, a Junior ISA is an excellent way to give your child a head-start in life by, for example, creating an American-style 'college fund' for university education.
3. Pensions
Lastly, well-heeled parents, grandparents and other relatives and friends can also set up pensions for the under-18s. In effect, children can invest in the same personal pension funds available to their parents and other relatives.
This loophole allows adults to contribute up to £3,600 a year into a child's pension and get 20% tax relief on these contributions. For example, a monthly contribution of £240 into a child's pension comes to £2,880 a year. Adding in £60 a month of tax relief (20% of £300) gives a total contribution of £300 a month, or £3,600 a year.
I find this tax relief incredibly generous. So, for several years, I paid the maximum £3,600 a year gross into pensions for both my son and daughter. After all, if the government is willing to refund them each £720 a year of tax they hadn't even paid, then I'm going to grab this gift with both hands!
Read more in Make your baby a millionaire!
Finally, some adults give money to children using the tax-free savings on offer from Premium Bonds and Children's Bonus Bonds, both issued by National Savings & Investments. However, while these bonds are tax-free, they also offer very low interest rates, so I am no fan of these N&SI schemes.
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