The two most common forms of saving for children is via a Bare Trust or a Junior ISA, however, there is a third avenue that is often overlooked: a Self-Invested Personal Pension (SIPP).
All three methods offer parents and grandparents the opportunity to save for their young children. Saving within a tax wrapper is always the most efficient way of saving, therefore a Junior Individual savings account or SIPP would seem the most logical solution. However, a Bare Trust can also offer some useful benefits.
I have been asked in the past what is the benefit of opening a Junior ISA. After all, a child is not going to have income of over £11,500 (the current personal allowance) per year, and it is highly unlikely that they are going to make use of their £11,300 Capital Gains Tax allowance (CGT) allowance.
This is true, but even with a Junior ISA allowance of £4,128 in the current tax year these savings can grow substantially.
Alternatively, another consideration might be a Junior SIPP. Again, within this account the investments are free from income tax and capital gains tax. You are able to add a total of £2,880 to a Junior SIPP, however unlike a Junior ISA the taxman automatically pays in 20% (£720) on any contributions, which means you will be able to invest up to £3,600 within a Junior SIPP.
Please note, when adding money to a Junior SIPP you are saving for your child’s long-term future, and investments can fall in value as well as rise. Also tax rules and benefits are likely to change between now and the time the child reaches retirement age (57 from 2028).
A further benefit to investing within a Junior SIPP is that gifts to a child’s pension can fall outside of your estate for inheritance tax purposes (IHT).
Both the Junior ISA and the SIPP are not mutually exclusive; you are able to save into both tax efficient wrappers, but it is worth remembering that as soon as the child reaches eighteen they will have access to the ISA, but will not have access to the SIPP until retirement – the latter is useful if you think a sound investment decision for an eighteen year old is spending their money down the local pub!
The final type of account available for children is called a Bare Trust Account. On the surface this may sound complicated, but the reality is this is a legal arrangement that anyone can setup.Unlike a Junior ISA or SIPP, there are no limits to what you can leave in trust. However, like the Junior ISA the child becomes entitled to the assets when they turn eighteen.
Whilst the Bare Trust is not a tax wrapper, there are still benefits in saving in this type of account, especially when it comes to Inheritance Tax. A Bare Trust can be used to mitigate any potential IHT liability. Providing the donor survives seven years after making the gift, it does not form part of their estate.
One factor to be aware of with Bare Trusts is how income is treated within the trust. Depending on the donor, the income tax liability will vary. If a grandparent makes a gift into the Bare Trust then this falls on the child.
In respect to income tax, providing it falls within the child’s allowances there is no tax to pay. Most children can earn up to £17,500 a year and not pay tax. This is made up of the personal allowance of £11,500 – a saving allowance of £1,000 and a £5,000 dividend allowance, although please note the dividend allowance is going to reduce to £2,000 in the 2018/19 tax year.
On the other hand, the parent is the donor of any income that exceeds £100 per year and will be taxed at the parent’s marginal rate. They will also have to declare it on their own tax return. It is for this reason that Bare Trusts are the preferred option for grandparents. One potential way round this for parents is to invest for growth, as opposed to income, however this is likely to make the portfolio more risky due to the fact that non-income paying companies tend to be smaller and younger.