Tax-efficient savings to help fund the next generation

In today's ever evolving financial landscape, many of us are increasingly focused on providing our children with a strong foundation for financial security.

Whether you’re looking to fund school/university fees, a house deposit, or even just a head start on a rainy-day fund, there are various tax-efficient options to consider.

JISA

Junior ISAs are a great way to start saving for your children as they offer tax-free growth, provided the annual contribution limit (currently £9,000 per child per tax year) is not exceeded. Like adult ISAs, the funds can either be invested in cash or stocks and shares, or a combination of the two.

Children can take control of the account at 16 and withdraw the funds at 18, when the ISA will mature into a normal adult ISA.

LISA

Lifetime ISAs can be opened by anyone between the age of 18 and 40 and are designed for saving for first-time buyer deposits and pensions. Once opened, contributions can be made until the account holder is 50 years old.

The annual contribution allowance is £4,000 per year, with the government adding a 25% bonus every year, up to a maximum of £1,000. Please note that this amount counts towards the annual £20,000 ISA contribution.

Funds can only be withdrawn free of charge if using the funds to purchase a property, or at the age of 60 to fund retirement.

Bank accounts

Under anti-avoidance rules known as the Settlements Legislation, interest earned from funds deposited into a bank account by a parent for a child under 18 will be taxable in the hands of the parent if the total interest exceeds £100 per year.

The same rule does not apply to interest earned on funds deposited by grandparents, however, and interest earned on these funds will be subject to tax in the hands of the child. If this is their only source of income, tax will only be payable if the amount received exceeds £17,570.

Trusts

Trusts provide a mechanism for funding expenses such as school fees, whilst not passing on full access to the capital and providing some protection from life events such as divorce.

There are various types of Trusts, but the most commonly established by parents and grandparents is the discretionary Trust. This type of Trust offers flexibility in determining what the children, as beneficiaries, receive and when.

Income generated within a discretionary Trust is subject to taxation at the additional rates of 39.35% for dividends and 45% for other types of income, payable by the Trustees. When these funds are distributed to children as beneficiaries, they come with a 45% tax credit. If the child has no other income, this tax credit can be reclaimed from HMRC.

It is crucial that Trusts are not only set up correctly, but that they are fully understood before any action is taken, particularly as legal ownership is transferred. Read our comprehensive guide on Trusts tax implications for further information.

Pensions

A Junior Self-Invested Personal Pension (SIPP) is another good option for parents and grandparents to help fund the next generation’s retirement, particularly if they have a lot of excess cash and the JISA limit has already been reached.

Whilst the child has no earnings, the maximum that can be contributed by a parent is £2,880 per year. HMRC will then contribute a further £720 resulting in a maximum investment per year of £3,600.

Whilst this is a long-term investment strategy as the child will not be able to access the funds until the age of 57, income and gains roll up in the pension tax-free and it provides a head-start for any pension plan they later enrol in.

Premium bonds

Premium bonds can be a fun way to gift excess cash to children and grandchildren and get them into saving, with minimum bonds of £25 and a maximum of £50,000 available.

Whist there is no guarantee of winning a prize, any prizes won are tax-free, even if the maximum amount of £1 million is won.

Inheritance Tax (IHT) implications

Inheritance Tax is an important consideration when gifting funds for any of the above investments.

All individuals are able to gift £3,000 per year (the annual exemption) with no Inheritance Tax implications, with the previous year’s allowance also available if unused.

Any amount in excess of the annual exemption will be a potentially exempt transfer, with no IHT implications if the individual making the gift (the donor) survives for seven years after the date of the gift. If the donor does not survive for this period, IHT may be payable at 40%, although there is potentially relief available if they survive for more than three years after the gift.

Gifts in consideration of marriage attract additional relief. Read our article on Inheritance Tax implications: making wedding gifts to your loved ones for further information.

Gifts to a Trust will be a chargeable lifetime transfer, if the amount gifted exceeds the available nil rate band (currently £325,000). IHT filings may be required to HMRC if the amount gifted exceeds 80% of the nil rate band.

Further guidance on the rates and reliefs for IHT can be found in our article on Inheritance Tax in a nutshell.

If you have any questions or need further assistance, please get in touch.