McLean’s Financial Services

An alternative gift for children this Christmas

Why not make an alternative gift to your children or grandchildren this Christmas, something they’ll still benefit from in future years?

Festive returns of the year
When investing for children there are numerous products to choose from, including bank accounts, National Savings & Investments, Child Trust Funds, unit trusts, individual savings accounts (ISAs) and stakeholder pensions. There are many choices to make, including whether to invest a lump sum or regular premium, the time scale, risk profile and tax considerations. Take a look at some of these festive stocking fillers.

Bank accounts
There are a number of accounts designed for children, and because these will often be held for a relatively long time they often offer higher interest rates. Cash deposits are very low risk and would be suitable for people who are extremely risk-averse or who are not concerned about inflation.

From a tax point of view, if the interest accruing in a tax year is less than the child’s personal allowance of £6,035 (2008/09), there should be no tax due. By completing an R85 form, typically available from the bank or HM Revenue & Customs, the interest will be received gross.

Care should be taken if the money is a gift from the child’s parents. In this situation, any interest above £100 will be taxable for the parents. If each parent makes a separate gift, they can each use their £100 allowance, thereby allowing interest of £200 to be free of tax.

Because of this, if a significant gift is to be made, it will often come from the grandparents or other relative as the £100 rule would not apply.

The National Savings & Investments Children’s Bonus Bond
You can invest between £25 and £3,000 tax-free for children under the age of 16 and the interest is fixed for five years. The Children’s Bonus Bond issue 31 pays a guaranteed compound rate over 5 years, including the 5th anniversary bonus, of 3.70 per cent AER tax-free. Tax-free means the interest is exempt from UK Income Tax and Capital Gains Tax.

AER (Annual Equivalent Rate) is a notional rate that illustrates what the annual rate of interest would be if the interest were compounded each time it was paid. Where interest is paid annually, the quoted rate and the AER are the same.

Child Trust Fund
Every child born after 1 September 2002 and receiving child benefit is eligible. The Child Trust Fund account is a savings and investment account for children. The account will belong to the child and cannot be touched until they are 18. Money cannot be taken out of the Child Trust Fund account once it has been put in.

Neither you nor your child will pay tax on income or gains in the account (provided that you are UK residents) and a maximum of £1,200 a year can be saved in the account by you, family or friends. Each contribution year starts on the child’s birthday and ends the day before their birthday.

Parents receive a £250 or £500 voucher to start an account and the government will make a further contribution when the child is seven. This top-up payment will be £250, or £500 for children in lower-income families. These payments will be paid direct into the child’s account.

There are two types of account, stakeholder and non-stakeholder. Broadly speaking, the stakeholder option caps the annual charges at 1.5 per cent of the account’s value but imposes certain investment restrictions. The non-stakeholder is more flexible but can levy higher charges.

Unit trusts and Open-ended investment companies (OEICs)
These are collective investments that pool investors’ money to allow a wider investment spread: in stocks and shares, bonds or other investments. Economies of scale mean that the cost of running a collective investment may be less than that for an individual portfolio. In general, even in these current turbulent economic times, shares should outperform cash deposits and inflation over the medium to long term.

Investment trusts perform a similar function to unit trusts and some have special savings schemes for children. If the investment is for a short period, a lower-risk deposit-based investment would probably be more suitable.
Children have their own tax allowances, the same as adults. It is possible, therefore, to use the child’s income tax allowance (currently £6,035) and capital gains tax allowance (£9,600).

Bare trusts
Because children are not allowed to hold investments, they are often wrapped in a trust. The simplest form of trust is a bare trust, with the investment held by an adult, usually a parent or grandparent, on behalf of the child.
However, apart from being the named holder (nominee), the parent has no beneficial right to the investment and must exercise control for the benefit of or on the instruction of the child. The income arising on the investment is taxed as part of the child’s taxable income and any capital gains as part of the child’s capital gains.
From a practical point of view the bare trust is extremely easy to administer because there is no trust document. The investment is made in the parent’s name and the existence of the trust is denoted by having the child’s initials in brackets. There is no additional cost in placing the investment in a bare trust.

Individual Savings Accounts (ISAs)
ISAs have proved to be very popular because of the tax benefits. The proceeds from cash and corporate bonds held within an ISA are tax-free. Dividends from shares within an ISA will have 10 per cent tax deducted, but there is no liability to higher-rate income tax and any capital gains are free from capital gains tax.

ISAs cannot be owned by children. However, many parents invest in ISAs in their own names but earmark the investment for their children. This flexibility may be useful as it does not tie in the parents, unlike unit trusts in a bare trust.

Stakeholder pensions
Stakeholder pensions were introduced by the government as a flexible, low-cost, tax-efficient way of providing income in retirement. They also allowed for contributions of up to £3,600 a year to be made on behalf of someone else, including children. As the contributions attract tax relief at the basic rate, an investment of £3,600 would cost only £2,880.

This facility therefore allows for parents and grandparents to start a pension very early in a child’s life. Even modest contributions can grow to a meaningful sum over a 50-year period. Stakeholder pensions can therefore offer a useful way of boosting a child’s pension. The only downside is that the child cannot touch the money until he or she is 55.

If at any time you are unsure about how much risk you are prepared to take, you should speak to us to receive professional advice.

Levels and bases of and reliefs from taxation are subject to change and their value depends on the individual circumstances of the investor. The value of your investment can go down as well as up and you may not get back the full amount invested.

For more information or to discuss anything in this article feel free to contact Doug McLean via email or phone.