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Investing For Children

Why you need to know:

Investing for the financial future of children and grandchildren are key areas of concern for parents and grandparents and, consequently, offer rich potential for the giving and receiving of financial advice. This is especially so in relation to providing for the cost of education, higher education and property purchase.


What you need to know:

There are special rules to consider when investments are made for the benefit of, or on behalf of, minor children. It is important to know and understand these rules when giving advice.

Fundamentals:


Legal fundamentals

When advising clients who are looking to make investments on behalf of children, it is important to initially ascertain whose money is being invested, as this will impact on investment choice.


For example, cash may have been gifted to a child or left to a child under the terms of a Will – in these circumstances, there is likely to be a trust (whether expressed or implied by law) and the investment will need to be made by the trustee(s), i.e. the adult who has legal control over the money.


In some cases, further questions will need to be asked to establish who owns the funds. For example, where cash has originated from a grandparent, then it would equally be possible that the gift was made to the parent in the hope that the money would be used for the benefit of the grandchild, but without conferring any legal obligation on the parent to that effect. This is a simple, but nonetheless important, point which needs to be ascertained so that the correct tax and legal consequences can flow.

Remember that in England, Wales and Northern Ireland, a child attains majority at age 18 (whereas in Scotland a child attains majority at age 16) and, until then, their rights to make contracts are restricted. This means that, generally speaking, a minor child cannot make an investment in their own name, so even if, on the face of it, the funds belong to the child, any investment will usually need to be made by an adult – as a donor, nominee or trustee (although special rules apply to bank accounts - please see below).


Tax fundamentals

Subject to the special rule applicable when the sums invested for the benefit of a minor originate from the child’s parent (please see below), for tax purposes, a child is treated in the same way as an adult and so is subject to income tax and capital gains tax (CGT) on their income and gains with the benefit of a personal income tax allowance, a personal savings allowance, dividend allowance, a starting rate tax band and a CGT annual exempt amount.

However, where income is produced as a result of a "settlement" (which covers all gifts) made by a parent for their unmarried minor child who is not in a civil partnership, the income is assessed on the parent unless the total gross income which comes from capital provided by the parent for the child does not exceed £100 gross in a tax year (known as the parental settlement rule). However, any CGT would be assessed on the child for funds within a bare/absolute trust.

Planning:


The tax rules outlined above mean that there are opportunities to take advantage of the child’s personal allowances and CGT annual exempt amount when investing for children. However, when parents make gifts for the benefit of their own minor unmarried children who are not in a civil partnership, greater care is needed in finding a tax effective solution. Subject to not unduly compromising the investment balance, this may be achieved with some non-income producing investments or by using certain trusts.


Investing in the name of the child:


In some cases, it may be possible (and desirable) to invest money that belongs to a child as of right (i.e. where there is no trust) in the child’s own name. There are a number of options in this regard:


(i) Bank or building society accounts

A child aged 7 or over may usually open a savings account and a child aged 11 or over may usually open a current account. However, where large sums are involved, accounts would usually be opened either as designated accounts or trustee accounts. Legally, a designated account will normally create an implied bare trust. However, the person who created the trust might have to demonstrate (to HMRC for example) a clear intention to make an irrevocable gift.


(ii) Junior ISA (JISA)

These were made available from 1 November 2011, for any child under 18 years of age, who is UK resident and does not hold a Child Trust Fund (please see vi below). JISAs permit up to £9,000 for 2021/22 per child to be invested in total (in a cash account and/or stock and shares JISA) by any one or more persons (e.g. parents or grandparents) for tax free accumulation of income and capital until age 18 when the JISA will convert to an ordinary (adult) ISA.


(iii) Registered pensions

It is possible for anybody to invest up to £3,600 gross annually into a registered pension plan for a child. The obvious disadvantage is that the funds will generally not be available until the beneficiary is aged 55.


(iv) Unit trusts

In most cases, these investments would be made by those over age 18 on behalf of the child, using a designated account. Here the unit trust certificate will be issued in the name of the adult nominee, followed (usually) by the child's name or initials to indicate the beneficial ownership. The nominee will have power to sell units/shares and to reinvest any investment income. At 18, the ownership of the investment can be transferred to the beneficiary - a stock transfer form would be needed.


(v) Life assurance policies

Typically, it will be necessary to use a trust where it is desired to invest in life assurance policies for the benefit of a child. Any chargeable gains made while the policy is in trust and the beneficiary is a minor will be assessed on the settlor, except where the trust is a bare trust and the settlor is someone other than the minor beneficiary’s parent. Offshore policies held in this way can offer tax-free accumulation and the potential for tax-free/tax reduced returns, e.g. under a bare trust where the beneficiary is taxed and has unused personal allowance and 0% tax bands (for parental settlements this will only work after the child attains age 18).


(vi) The Child Trust Fund

An overview of the Child Trust Fund (CTF) is included in a separate guide. No new CTFs can be established from 1 January 2011, but CTFs set up before that date can continue and top-ups can be made (although of course no further Government contributions are paid). From 6 April 2015, it has been possible for those with a CTF to transfer into a JISA, should they wish to do so.


Using trusts when investing for children:


Many investment strategies for children will, or should, involve a trust. Sometimes, there will be an implicit trust that has arisen through the operation of the law (for example, where funds have been paid over to a parent or other adult on the condition that they will be used to benefit the child). In other cases, the donor may want to expressly create a trust for the child – either for tax reasons or to benefit from the additional flexibility and control that trusts can offer.


The question then arises as to what type of trust should be established. This will depend on the rights which are intended to confer on the beneficiary, how much flexibility is to be retained, the importance of any tax considerations (for example, where the settlor is the parent of a minor, unmarried child not in a civil partnership) and what the underlying investment is to be.


Generally, one of two types of trust can be appropriate. These are:

  • An absolute (bare) trust;

  • A discretionary trust.

Where there is a desire to optimise the CGT position on investments for children, a bare (absolute) trust will often be considered. The advantage is that all capital gains are taxed as the child’s with the benefit of a full CGT annual exempt amount, but a significant downside is that the child can demand the trust fund to be paid to them once they attain age 18 (16 in Scotland).


For many donors this may not be an attractive proposition especially where larger sums are involved which the child would have access to at such a young age. Thus, the potential for continued control and flexibility will often outweigh any CGT and/or income tax advantages. A discretionary trust, with a trustee CGT annual exempt amount (at one half the individual exemption) even in cases where the settlor´s minor, unmarried children can benefit, may not be so detrimental. The use of an investment bond could be advantageous due to the ability to defer chargeable event gains until surrender and create an “income” using the tax deferred (cumulative) allowances.


It will all depend on the facts – especially the level of anticipated gains and income.

The choice of an appropriate trust will depend on the circumstances and objectives – all advisers should know about trusts and their tax treatment before advising on this.


Past performance is not a reliable guide to the future. The value of investments and the income from them can go down as well as up. The value of tax reliefs depend upon individual circumstances and tax rules may change. The FCA does not regulate tax advice. This newsletter is provided strictly for general consideration only and is based on our understanding of law and HM Revenue & Customs practice as at 28 June 2021 and the Finance Bill 2021. No action must be taken or refrained from based on its contents alone. Accordingly, no responsibility can be assumed for any loss occasioned in connection with the content hereof and any such action or inaction. Professional advice is necessary for every case.

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