Christmas gifting: give kids a present that will keep on growing

You won’t be alone if you’re thinking there’s too much plastic under the Christmas tree, with lots of money being spent on toys that are quickly forgotten.

Paying money into an account isn’t, admittedly, a terribly exciting gift – especially for younger children – but over the years an investment on their behalf could grow into something a whole lot more impressive than a new toy or game.

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Even better, if you’re thinking about ways to reduce a potential inheritance tax (IHT) liability, it could do you all a favour too. By giving away money during your lifetime they’ll get the full benefit of your generosity without losing 40% to HMRC.

However, while you can use any old “wrapping” for a new toy or bit of tech under the tree – if you’re giving an investment for Christmas this year, it pays to think about the “wrapper” you use.

Here are a few ideas to think about – what works best for you will depend on your hopes or motivations for the gift.

Savings accounts/prepaid cards

If you want to give children cash, a savings account that pays a decent rate of interest is a great starting point. This can be a helpful way to teach them about interest and the benefits of saving too, especially for older kids that might already have a goal in mind.

As far as tax is concerned, children have the same tax allowances as adults. However, parents giving children larger sums should bear in mind that if their deposits earn them more than £100 in interest each year, their savings will be taxed as if it’s the parents’ money. This rule only applies to money given by parents, though, not other family members.

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A junior cash individual savings account (JISA) will shelter children’s savings from tax, but they won’t be able to access the money until they turn 18.

Another option, if you just want to make sure a child in your family has money to spend on holiday or when they are out and about, is a pre-paid card. Money can be loaded on in advance and then the child can use the card to spend, just like a debit card. They won’t be able to go overdrawn and many cards have helpful apps that let parents manage how much they can spend or withdraw in one go.

Junior ISAs

If your priority is to help prepare them for adult life, an ISA will provide the perfect wrapping for your gift. The child won’t be able to access the money until they are 18 and all gains are tax free.

Like adults, all children have an ISA allowance, but theirs is lower at £9,000 a year. Although ISAs need to be opened by a parent or guardian, anyone can contribute.

Parents can choose between cash or stocks and shares JISAs and, if they want, can open one of each. However, while interest rates on cash accounts aren’t too shabby at the moment, the outlook for interest rates is downward, and over a period that could span 18 years, kids will likely end up with a bigger nest egg if their money is invested in stocks and shares.

As children get older, investing money in an ISA can help teach them about the stock market as well. You might even want to let them use some of their money to research and buy a share or two.

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The catch with ISAs is that the money will legally be the child’s and they will be able to access it as soon as they turn 18. That means they could, potentially, blow the cash instead of using it to support their financial future. However, by having ongoing conversations with children about their nest egg and the costs they’ll be facing as adults – whether that’s going to university or buying and insuring their first car – you’ll increase the chances of them making sensible choices.

The size of their nest egg will ultimately depend on how much is invested on their behalf. However, even a one-off gift of £3,000 when they are a baby – perhaps as part of an IHT gifting strategy – could be worth £7,220 after 18 years (assuming growth of 5% a year net of fees).

Unless they withdraw their money as soon as they can, JISAs are converted into adult ISAs at age 18 and their annual allowance increases to £20,000 a year.

If you are thinking about giving children larger sums of money and you want more control over how and when they get it, it’s worth speaking to a regulated financial adviser about trusts.

Junior SIPPs

Another option, if the thought of a reckless 18-year-old spending their nest egg worries you, is to set them up with a pension. That way they won’t be able to touch the money until they’re approaching retirement.

Setting up a pension for a child might seem a bit extreme, but it’s actually an incredibly savvy move. The combination of compounded investment growth for 60-odd years and tax relief means you can really milk a modest investment.

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Each year it’s possible to invest £2,880 into a Junior SIPP which, after 20% tax relief has been applied, will be bumped up to £3,600. Assuming that investment is made each year, and averages 5% growth annually, they could already have a pension worth around £110,000 by the time they leave school. And, even with no further contributions, that pot could be worth around £854,000 by the time they reach 60. Not bad for a total outlay of just under £52,000.

How Christmas gifts can cut your IHT bill

If you are worried about paying IHT, setting up a savings or investment plan for a grandchild (or other younger relative), could also help you reduce your bill.

Each year you can give £3,000 to anyone and that money will immediately be outside your estate for IHT purposes. You can also give as many gifts worth up to £250 a year as you like (so long as the recipients don’t benefit from any other gifting allowance) without bothering the taxman.

Another option, if you want to carry on funding an investment for a child (rather than just kick-starting it with a lump sum), is to make use of the regular gifts from surplus income exemption. So long as you are able to demonstrate that the gifts were made from income (rather than capital) and that they didn’t affect your standard of living, you can give away as much as you like IHT free. Birthday and Christmas gifts are also IHT free, but again they need to be from regular income – you can’t raid a savings or investment account to fund it.

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Beyond the official IHT allowances, any other gifts will be considered as “potentially exempt transfers”. This means that they will only become totally free of IHT if you survive for a further seven years after making the gift, hence you might see this referred to as the “seven-year rule”. If you die before seven years are up, a reduced rate of IHT may apply, depending on the number of years that have passed.

Of course, the rules don’t just apply when you’re setting up savings and investments plans for kids. They can also be used for any other monetary gifts you’re thinking about this Christmas. For example, chipping in for a house deposit if you’ve got a struggling first-time buyer in the family. Or, if you’ve got a winter wedding in the diary, you can make use of the wedding gift allowance. This lets you give £5,000 tax free to a child who’s getting married, £2,500 to a grandchild or great-grandchild, or £1,000 to anyone else.

Giving money to younger generations can be very rewarding for some people and the fact that it can cut a potential tax bill will only put the fairy on the tree. The important thing, however, is to start off cautiously and only give away money you are confident you won’t need yourself in later life.