Back to school: time to get saving for your kid’s future

Whether your kids – or grandkids – are starting school for the first time, or just going up a year, September is always a reminder of just how fast they’re growing up. And, if you’ve just had to kit them out with new school uniform or signed them up to a new raft of clubs or after-school activities, it’s also a timely reminder of just how expensive they can be.

But, however pricey they’re feeling right now, many parents of older kids will attest the most expensive years are yet to come. This is especially the case if you (or other family members) want to support them with any of the costs they’ll face as a young adult, from buying a first car to going to university, or even helping them with a deposit on a home of their own.

• Invest with ii: Transferring a Junior ISA | The Junior ISA Annual Allowance | ii Friends & Family

Without any planning for those expenses, it’s often difficult to spare the sums you’d like to give your children, particularly if you’re grappling with your own financial challenges such as paying off your mortgage or topping up your pension.

However, if you start planning early (when exams and university still feel like a lifetime away), it’s possible to harness the power of compound returns and build a sizeable nest egg, without too much sacrifice.

• Helping your child buy their first home? Make sure you do it tax-effectively
• How to invest for…buying your first home

The longer you invest, the less you will need to save overall.

Take the example of a £10,000 nest egg – a helpful leg-up for any 18-year-old. Assuming returns of 5% a year, parents would only need to save £65 a month if they started saving when their child was eight. However, if they left it until the child turned 13, giving them only five years instead of 10, they’d need to find a heftier £148 a month.

Had they been super-organised and given themselves 18 years to save, they would only need to put away £29 a month to reach the same goal.

Over 18 years, our saver only needs to put away £6,264 to save £10,000, rising to £7,800 over 10 years. But if they only give themselves five years, they’ll need to stump up a much more substantial £8,880.          

Kids’ savings options

There are number of ways to put money away for children. Get up to speed with a quick lesson on your options.

Junior ISA

In the 2021-22 tax year, under 15s paid a whopping £13 million in capital gains tax (CGT), according to HMRC data, and with the capital gains tax threshold cut to £6,000 this year, and a further reduction to £3,000 scheduled for April 2024, that’s a figure that’s only likely to grow.

However, by holding investments in a Junior ISA, all gains will be tax free. Each year, you can pay £9,000 into a Junior ISA and the money cannot be accessed until the child turns 18.

You can use a cash or stocks and shares Junior ISA, but even in spite of rising interest rates, if you have a long investment horizon (ideally 10 years-plus), you’ll usually get better returns with stocks and shares.

At age 18, the account will be rolled into an adult ISA, with an increased allowance of £20,000 a year.

Junior ISAs are a tax-effective way to save for children, but the major catch for parents (and grandparents) is that the money is legally the child’s and they can spend it as they wish, as soon as they’re 18. And, whatever their circumstances, their financial priorities may not be the same as yours.

Use your own ISA allowance

Each year, you can invest £20,000 into your own ISA, meaning a couple can between them shelter £40,000 from tax. 

So, if you aren’t using all your allowance each year, you can also save for children or grandchildren, with your own ISA.

There are several upsides to this approach. First, you can potentially save more than £9,000 each year but second, and perhaps more importantly, you are only earmarking that money for them and it will remain legally yours until you hand it over. This means you’ll have much more control around when and how you give it to them, and it reduces the risk of them frittering it away. If you want it to go towards a house deposit, for example, you can hold off giving it to them until they’re ready to buy.

• Your top ISA questions answered
• Five ISA lessons that nobody taught you at school
• My first four years as an ISA investor

The downside is that it can be confusing having their savings mixed in with yours. Without ringfencing their cash, you could end up spending money you had set aside for them. It will also still form part of your estate for inheritance tax (IHT) purposes.

Junior SIPP

Another option is to consider a Junior SIPP for your child. With an investment horizon that could span 50 years or more, you do not need to invest much to make a real difference to their retirement finances. Non-taxpayers can pay up to £2,880 into a pension each year, which will be boosted to £3,600 by basic-rate tax relief. Do that once and without making any further contributions, your child could have £43,630 in 50 years’ time (assumes 5% growth).

A Junior SIPP is worth considering if you’ve exhausted other savings allowances and plans are already in place to help with the financial challenges they’ll face much earlier in their life. It’s also an option for those with concerns about how young adults might spend the money.

Trusts

If you’re planning to save larger amounts for children, you can also make payments into a trust.

A discretionary trust will give you control over who gets the money and when, but they aren’t tax friendly. The payment would be considered a ‘chargeable lifetime transfer’ and could be subject to IHT. Annual income on the trust may be taxable too and CGT could be payable on asset sales.

A bare trust is more tax-effective but the child will get access to the money on their 18th birthday, meaning you won’t have the same degree of control.

• Grandparental giving: sharing your wealth and seeing the benefits
• Tips on gifting and inheritance tax

The complexity of trusts means it’s essential to get professional advice.

Can saving for a grandchild reduce my inheritance tax bill?

For grandparents, saving or investing for children can be helpful way of reducing a brewing IHT bill. 

Gifts made from income won’t be subject to inheritance tax (so long as it does not affect your standard of living) meaning a regular saving plan could be a tax-effective way to put money aside for their future.

Lump-sum investments may be free of IHT too if they fall within the IHT gifting allowances (£3,000 a year), otherwise they will be considered potentially exempt transfers. This means that they will only become totally IHT free if you live for seven years after making the gift.