Last week we looked at the importance of saving for children and at Junior ISAs as a way to invest for their future. In this post we'll look more closely at two other ways to invest for children.
Self Invested Personal Pensions (SIPPs)
You can open a SIPP for a child under 18 and get tax relief to help their retirement fund grow for longer. Many parents and grandparents use the tax benefits of SIPPs to set up pensions for their young children and grandchildren. The advantages of such a head-start are hard to ignore because of the funding worries over state and company pensions.
Why it makes sense to start a SIPP early
Less than half of Britons are actually saving for when they retire (Source: Department for Work and Pensions, April 2010). Yet to expect an annual retirement income of only £15,000 in today’s money, children will need to save the equivalent of £203,528 by the time they retire. If you start saving at 25, this means putting aside £449 a month until the age of 65.
However, thanks to the power of compounding returns you don’t have to pay thousands of pounds a year to make a difference. Put away £39 a month for the first 18 years of a child’s life, and with tax relief boosting the contribution to £50 a month, it would be worth £506,064 when your child reaches 65 (assuming 6% growth, source Association of British Insurers and James Charles, The Times, January 2008). The level of tax benefits and liabilities will depend on individual circumstances and may change in the future.
Points to remember
- Under current legislation, you can open a SIPP on behalf of a child under the age of 18
- The Government will pay tax relief on contributions up to a maximum of £3,600 per annum, i.e. you pay £2,880 and the government will provide £720 in tax relief
- Once the child reaches the age of 18, they can take over the management of the SIPP and make their own contributions to it, receiving tax relief in their own right
For more on SIPPs, please just download our free SIPP Guide.
Please remember that the value of investments and the income from them may fall as well as rise and you may not get back the full amount invested.
Bare trusts as a way to invest for children
Bare trusts are another way to invest for children. They give the beneficiary (the person who benefits from the trust) an immediate and absolute right to both the capital and income in the trust. Beneficiaries will have to pay Income Tax on income that the trust receives. They might also have to pay Capital Gains Tax and Inheritance Tax.
What is a Bare trust?
A Bare trust is one where the beneficiary has an immediate and absolute right to both the capital and income held in the trust. Bare trusts are sometimes known as 'simple trusts'. Someone who sets up a Bare trust can be certain that the assets (such as money, land or buildings) they set aside will go directly to the beneficiaries they intend. These assets are known as 'trust property'. Once the trust has been set up, the beneficiaries can’t be changed.
The assets are held in the name of a trustee - the person managing and making decisions about the trust. However, the trustee has no discretion over what income or capital to pass on to the beneficiary or beneficiaries. Bare trusts are commonly used to transfer assets to minors. Trustees hold the assets on trust until the beneficiary is 18 in England and Wales, or 16 in Scotland. At this point, beneficiaries can demand that the trustees transfer the trust fund to them.
Bare trusts and Income Tax
Trustees may receive income from investments such as bank interest, dividend income from stocks and shares or rental income from land or buildings. The beneficiary is liable for Income Tax on income received by the trust. The beneficiary is responsible for this tax, but it may be paid by the trustee.
Bare trusts and Capital Gains Tax
Capital Gains Tax is a tax on the gain in the value of assets such as shares, land or buildings. A trust may have to pay Capital Gains Tax if assets are sold, given away or exchanged (disposed of) and they’ve gone up in value since being put into trust. The trust will only have to pay the tax if the assets have increased in value above a certain allowance. This allowance is known as the 'annual exempt amount'. The assets of a Bare trust are treated for tax purposes as if the beneficiary holds the trust assets in their own name. In a Bare trust the beneficiary pays the tax as if they owned the assets directly. If you're the beneficiary you must declare any chargeable gains on your personal Self Assessment tax return.
Bare trusts and Inheritance Tax
Inheritance Tax is sometimes payable if the person who put an asset into the Bare trust dies within seven years of doing so. This is known as a 'potentially exempt transfer'. The beneficiary is responsible for this tax.
Facts surrounding Bare trusts:
- Once a deed has been prepared it is irrevocable
- Assets placed in a Bare trust are treated as potentially exempt transfers for IHT purposes
- This means that if you survive for seven years after making the gift, the capital value will fall outside your estate
- The beneficiary has an immediate and absolute right to the fund and any income arising from it
- The trustees have no discretion
- Income tax is chargeable to the beneficiary as if they hold the funds in their own name (unless the Bare trust was created by their parent in which case if the annual income amounts to more than £100, it is assessed as the parent’s income)
- When the minor becomes of age (18 in England and Wales), they become absolutely entitled to the funds and these must be transferred to them
- There are no restrictions on the amount that may be placed into a bare trust
You should, of course, only consider investments that are right for you. If you are in any doubt about the suitability of an investment, please speak to an Independent Financial Adviser.
In the last of this 3 part blog series, we will take a closer look at designated accounts, discretionary trusts and NS&I Children’s Bonus Bonds.
As always, if you have any questions or thoughts on the points I've covered, please leave a comment below or connect with us @ISACO_ on Twitter.
Please note past performance should not be used as a guide to future performance, which is not guaranteed. Investing in Funds should be considered a long-term investment. The value of the investment can go down as well as up and there is no guarantee that you will get back the amount you originally invested.
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