So far in this series we've looked at some key ways of saving for a child's future, including Junior ISAs and SIPPs. In this post, we'll look at some other popular ways of investing for children.
Designated accounts
This is a simpler option than a Bare trust, as the investments are simply held in an account with a designation (such as Simon Smith a/c ABC). You simply hold an account in an adult's name, but give it a label such as the child's initials or name to identify which assets are the child's.
You can complete the forms in your own name, but write the name of the child in the section headed 'Designation'. As a result, the account holder retains complete control over the timing of the asset distribution. However, this also means the account holder remains liable for income tax and capital gains tax. The assets remain part of an estate when an inheritance tax bill is being calculated. It may be worth considering this option if you require access to the investment before the child is 18, for example, to pay for school fees or general expenditure.
Please note that designation may not be considered by HM Revenue and Customs as conclusive evidence that the assets have been given to the child. This is a complex area of tax planning and you may need to seek guidance from a financial adviser.
Investing for children with discretionary trusts
Discretionary trusts are sometimes set up to preserve a capital sum for future generations and offer another way of investing for children. The trustees are responsible for running the trust for the benefit of the beneficiaries. The trustees have control of the funds and will use their discretion regarding how much and when payments should be made to a class of beneficiaries. The trustees may also be able to 'accumulate' income and add it to capital. The class of beneficiaries may be as large or small in number as you like, but they must amount to more than one and it must be possible for the trustees to be able to identify who might fall into that class, e.g. ‘all my grandchildren.’ The extent of the trustees’ discretion is laid out in the trust deed.
Assets in a discretionary trust are legally owned by the trustees. This means you have control over the child’s access to the money. These assets are known as 'trust property'. These trusts need a bespoke trust deed that should be set up with advice from a solicitor. The trust will also need to produce annual accounts and tax returns, so there will be ongoing costs. It is worth noting that all income in these trusts is taxed at either 42.5% or 50%, while capital gains in excess of the annual exempt amount are also taxable
Although discretionary trusts are taxed at the higher rates, when income payments are made the additional tax can be reclaimed by beneficiaries who are lower rate, higher rate or non-taxpayers. Before any payments are made, you should consider whether enough tax has been paid during the year by checking the ‘tax pool’. It is important to keep a record of the ‘tax pool’ as the Trust will be liable to additional tax if an over distribution of income is made.
Trustees may be able to decide:
- how much income and or capital is paid out, if any
- which beneficiary to make payments to
- how often the payments are made
- what, if any, conditions to impose on the recipients
Discretionary trusts have become a less favourable way of investing for children over recent years due to their tax treatment. However, they are a way of protecting capital and there is no reason why a beneficiary should become absolutely entitled to a share of the fund at age 18. If you would like to invest for a child until they are say age 25 this is one of the very few options available to you.
Discretionary trusts are sometimes set up to put capital aside for:
- a future need that may not be known yet, for example a grandchild that may require more financial assistance than other beneficiaries at some point in their life
- beneficiaries who are perhaps not capable or responsible enough to deal with money by themselves
Under the terms of the deed that creates the trust, there may be situations when the trustees have to use income for the benefit of particular beneficiaries. However, they may still retain discretion about how and when to pay. The extent of the trustees' discretion depends on the terms of the trust deed.
Final thoughts on Discretionary trusts
Before any distributions are made, you should seek advice as the payments can have various tax implications for the trust and the beneficiary. If you are a beneficiary, it is important to check whether you are entitled to reclaim any tax that has been paid by the trustees and, in some cases, it may be possible to reclaim tax for the previous 4 years. As always, the taxation of trusts is an ever evolving subject and there is no guarantee that these rules will continue to apply in future. If you are in any doubt as to the taxation of the trust, you should seek specialist advice before any action is taken.
NS&I Children’s Bonus Bonds - a secure way of investing for children
You can give a child a tax-free head start in life with this guaranteed investment. NS&I Children’s Bonus Bonds allow you to invest for a child’s future in their own name – and there’s no tax to pay on the interest or bonuses. NS&I Children’s Bonus Bonds offer fixed rates of interest plus a bonus every 5 years until the child’s 21st birthday.
- rates guaranteed for 5 years at a time
- bonus every 5 years
- free of UK Income Tax and Capital Gains Tax
- invest up to £3,000 in each Issue
100% secure
When you choose Children’s Bonus Bonds, your money will be 100% secure, as NS&I are backed by the Treasury – with no limit on the amount that is guaranteed. They are also tax-free, but you have to save for the full five-year term to receive the bonus. The savings can then be rolled over into another five-year bond and are finally paid out on the child’s 21st birthday (though the child has control of the money from the age of 16, so they can choose to withdraw it earlier if they want). However, these bonds do not offer high returns, particularly when you consider that you are locking money away for five years at a time. (Currently 2.5% AER, August 12th 2012).
Are they right for you?
They may be right if you if you want a long-term tax-free investment for your child's future, want to invest for a young person over 16, have £25 or more to invest, want an account that the child can control and can leave the money invested for 5 years at a time. However they may not be right if you want to invest for a young person over 16, want an account that the child can control or might need access to the money within the first year.
Suitability
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.
I hope you've enjoyed this blog series on investing for children. 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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