How Should I Save For My Grandchildren?
With things looking tougher than ever for young people struggling to become financially independent, setting some funds aside for your grandchildren’s future could help make a real difference.
When it comes to selecting a method of growing your capital, grandparents are somewhat spoiled for choice. Whilst this means you’ll ultimately be able to go with a way of saving that will be suited to both you and your loved ones, it can make the process of finding that perfect option (or, indeed, the perfect combination of options) a little tricky.
Luckily help is at hand. In this comprehensive guide we’ll talk you through the various vehicles you could use, explain how they work and give an insight into their plus points as well as their potential pitfalls.
- Do Junior ISAs Offer A Good Deal?
- Are Child Trust Funds Still An Option?
- Are There Savings Accounts For Grandchildren?
- Easy Access
- Regular Savers
- Fixed Rate
- Credit Unions
- How About Buying Premium Bonds?
- Should I Buy Shares For My Grandchildren?
- Investment Trusts
- Unit Trust
- Index Funds
- Can I Open Them A Pension?
- Are There Any Tax Issues?
- Inheritance Tax
- Capital Gains Tax
Are Junior ISAs The Best Option?
If your grandchild was born after the 3rd of January 2011, or if they were born before September 2002 and are still under 18, they’ll be eligible for a Junior ISA. (Children born between those dates will have a Child Trust Fund instead, more on which down the article.)
As with any other ISA the returns earned by the money you deposit are tax free. There is a limit on how much you can pay in each financial year (currently £3,720) and unused allowance cannot be carried over.
Once money is paid in it can’t be withdrawn again until the account holder reaches 18, at which point they have full control of the funds. Guardians retain control of the account up until this point, although the holder can take over the running of the account at 16 if they wish. Though guardians can’t withdraw from an ISA, they can move provider any time they wish.
Once the holder is 18, the funds are simply moved from the junior ISA to a regular ISA. They do not need to be withdrawn unless the account holder so wishes.
There are two kinds of Junior ISA to choose from:
- Cash: These work in the same manner as a savings account, with money deposited earning interest at a rate set by the provider. At present 3.25% represents a market leading rate.
- Shares: The money you pay in is invested in a range of shares and earns a return depending on how well they perform.
Whilst buying shares present a risk, they can also bring substantially bigger returns. In general, if you are making a long term investment, you are less at risk as there is time for the markets to recover from blips or even major crashes.
You do not have to choose between cash or shares. You can have one of each option per a child. You can also transfer Junior ISAs, not only between providers, but also from cash to shares options and vice versa. Note that the annual pay in limit of £3,720 applies to both ISAs combined. You can split the allowance between them as you wish.
Things to Consider
- How Much Will The Tax Benefits Be Felt?: As a grandparent, interest earned from money you give to your grandchildren is tax free anyway. On top of this, even without the protection of an ISA, tax only has to be paid on interest from money paid in by a parent once it exceeds £100 a year. If they have two parents saving for them, that would be £200. That’s a lot to earn in interest in a single year by most people’s standards.
The only other time a child would be taxed would be if their annual income exceeded the personal allowance of £9,440. It’s very rare that that would apply.
However, in later life your grandchildren may find themselves in the higher rate tax band and facing substantial bills from the HMRC. By having built up a healthy pile of tax protected savings before they’ve even started earning you could be helping them on their way to earning some serious money that they’d otherwise have to pay as much as 40% on.
The fact that the real benefits of an ISA (i.e. protection from tax) will only come in later life provides a good incentive for your grandchild to keep building on the fund you’ve started as they get older, rather than simply spending it the second they get their hands on it (provided, of course, that the way the ISA works is clearly explained to them.)
- Funds Are Locked Away: Once you’ve paid money in, you can’t get it back again. If your generosity later leaves you struggling, there’s nothing you can do to get reclaim your gift. If, as discussed above, the tax benefits don’t really come into play, you need to consider if the returns on offer justify having your money locked away for so long. For example, you might be able to get a better rate from a high interest bond with a shorter term in your own name or the child’s. This would also give you more control over your investment…
- Lack of Control: You’ll have no say in how the money is spent. Once you grandchild is 18 they can do with it as they will. When they are younger the account is in control of their guardian, so unless that’s you, you can’t control how the money you put in is managed. For example, you might put in £1,000 into a shares based ISA only for it to be switched to a cash option.
What About Child Trust Funds?
If your grandchild was born between 1 September 2002 and 2 January 2011 they will have a CTF. This is a tax free account to which anybody can contribute. Indeed, contributions are started by HMRC, who would’ve provided a voucher for £50-£250 to be put into the account when the child was born.
Only a set amount can be deposited in the account each year. This is currently £4,000. (Be sure to let other contributors know before you pay in, as there will be penalties for going over this limit).
This allowance is renewed on the child’s birthday and then applies until their next one. The child’s guardians are responsible for managing the account (but they can take over this role themselves at 16). When they reach 18 they take complete control of the funds and can spend them however they wish. No money can be withdrawn until this time, nor can it be transferred to a different type of account or investment vehicle (though you can switch providers.)
There are 3 kinds of CTF your grandchild might have:
- Savings: Pays tax-free interest on the money deposited. Rates are set by the provider. At present the most competitive accounts offer around 3%. You can move to another provider to get a better rate at any time.
- Stakeholder: The money deposited is invested by the provider. There are limits on the types of risks they will take, and they are obliged to spread these across a range of investments, industries and markets. They will also move the money into lower risk areas as the child gets older. You cannot be charged for transferring this type of CTF to a different provider and the most they can charge for managing the account is 1.5%, though the actual amount may well be lower.
- Shares: Again the funds deposited are invested. You can either have the money go into your preferred fund from a small selection put forward by the provider (which you can later switch between) or, alternatively, you go for a ‘self select’ option. In this case you can pick a fund from a wider range and also buy shares directly if you so wish. Charges vary considerably depending on the type of account you go for and are often higher than you’d pay with a ‘stakeholder’ option.
Which kind of CTF your grandchild will have is down to their guardian, however, if you are planning to contribute you should understand what type of account you’re paying into. Only ‘savings’ options are risk free, however, the government do recommend going for an investment based option. Though it is possible that the value of investments could go down, historically investments outperform savings in the long run, and, as the money is locked away until the account holder reaches 18, you are dealing with the long term.
Things to Consider
There are some key criticisms of CTFs you should be aware of before choosing whether you want to save for your grandkids using such a product:
- Banks Have Less Incentive to Be Competitive: Now that Junior ISAs are in place banks are vying to win business in that area and worrying less about catering to those already on a CTF. As a result the rates on offer may go down across the board. As you can’t take the money out or transfer it to another product it means you could be lumbered with an underwhelming return.
- Lack of Control: Once the account holder is 18, it’s their money. There are no caveats or conditions you can place on their spending. As such, paying into a CTF while your grandchild is very little is a bit like handing over a lump sum of cash to someone you haven’t met yet.
Aside from Junior ISAs and CTFs there are range of other products you can use to put money aside for your grandchild. These can be broken up into two broad groups: those that involve risk and those that don’t.
Risk Free Options
In general, any product that offers a return by paying a rate of interest can be considered risk free. This is because, unlike other investments, the only way you could end up financially worse off is if inflation were to outstrip interest rates.
Here’s a look at your interest based options;
Savings Accounts For Grandchildren
You can open a savings account in your grandchild’s name. Depending on how you wish to go about depositing money in the account there are a couple of different routes you could take.
- Easy Access: With an easy access account you’ll be able to pay in as and when you like and withdraw money you’ve put away at any time without penalty. The best rates tend to be in the region of 2%-3% but these can change according to fluctuations in the base rate or on the whim of the bank.
Normally minimum deposits are simply notional amounts (£1, for instance) however, maximum deposits are often potentially restrictive, with £20,000 being the limit in many cases.
- Regular Savers: With these accounts you have to deposit each month. The amount deposited will normally have to be between a minimum of £10 or so and a maximum amount of around £100.
The account will usually only be open for a year, or else until a maximum deposit limit has been reached (this puts a cap on how much you get from such an account). There will be penalties for withdrawing from the account before this time. However, in return for these various restrictions, you will get a higher rate. The market leader offers 6%, but around 4% is more common. Rates are variable.
- Fixed: With these accounts a set rate is paid over a set term, for example, you can secure a return of 2.5% over 5 years. You won’t be able to withdraw during this time and there will be a fairly low ceiling on how much you can deposit, £3,000 being typical.
Things to Consider
With interest rates so low it could be easily argued that now may not be the best time to go for a long term fixed account. On top of this you can better rates from a regular saver account which you only need to commit to for a year. After milking a good rate you’ll be free to switch around and see if you could do the same again.
If you do want the security of a fixed rate you could use the peace of mind it will give you to offset a more adventurous investment, perhaps using a shares based fund to chase a better return.
- Credit unions can be a great alternative to the accounts on offer from the traditional high street banks. They are not-for-profit organisations that are setup and run in the best interests of their members and the community. They generally exist to serve people in a particular location or workers of a specific industry.
The rate you will receive from on savings in a credit union are not always apparent up front as they pay a dividend rate based on how well they have done that year, in contrast to the stated interest rates you will get from most other institutions.
This does not meant that they offer bad rates, and for junior accounts the rates can be surprisingly good. The rates are decided by the committee in charge of the union so if they decided that child savings are more important, they can award greater dividend rates to those.
In fact, the Greenwich and Bexley Credit Union paid out a rate of 5% on junior savings in the year ending April 2014 and 4% in the year before that.
You can find your nearest credit union using the search functionality on this helpful website.
Do Premium Bonds Offer A Good Rate Of Return?
You can buy premium bonds for your grandchild and then nominate a guardian/parent to hold them. Your gains from premium bonds are tax free. Though premium bonds are risk free (NS&I, who run the scheme, are backed by the treasury so you can’t lose your capital) it’s actually something of a gamble as to how much interest you’ll be paid.
For every £1 you put in you receive a bond. Each bond is entered into a draw each month. 1.8 million bonds will win £25, 30,000 bonds will win £50 or £100 and 5,000 will win between £500 and £1,000,000.
There are about 44 billion bonds in the country and you can hold a minimum of 100 or a maximum of 30,000. On the basis of the probabilities involved you can expect a return of about 1.5% per a year. This in the same region as most adult savings accounts at present due to historically low interest rates.
Things to Consider
As premium bonds are tax free this normally may makes them a more attractive investment depending on how much tax you’re expecting to pay. However, as explained above, children wouldn’t be paying tax on interest they earned with your money anyway, so it doesn’t really make sense to consider this a bonus.
In addition, you need to be aware that this average of 1.5% is heavily skewed upwards by the big prizes. Most people will receive less than this. Of course, there is always a chance you’ll win big, so it can be worth putting some money aside in this way, but you should probably consider using other methods of saving in conjunction with it.
What About Investing In Shares?
Shares are usually considered the best form of long term saving. Though the value of your investment can go down, so long as you spread risk, over the years your money is likely to grow at a rate that will outperform even the most generous interest rates.
Under 18s cannot hold unit trusts or investments trusts in their name, but you can set one up and name as the beneficiary and they’ll receive the money when they come of age. Income will be treated as theirs, which can add a tax efficiency boost to your returns.
Putting your money in an investment trust is a bit like buying shares in a company. There a limited number of ‘shares’ available and, depending on how many you own, you’ll get a cut of the profits the fund makes. As with any other company, you can buy shares in an investment trust through a stockbroker.
All those investing will pool their money together, putting in the hands of fund managers who will then put together a diverse portfolio of stocks, shares and other assets from around the world. This variety means risks are relatively low.
To buy into an investment fund not only will you need to pay the broker commission, you’ll also have to pay management costs, but these are lower than with other forms of managed investments.
These are similar to investment trusts in that they are a managed, collective investment. As with an investment trust, you’ll benefit from economies of scale in paying for the charges involved and you’ll gain easy exposure to a diverse portfolio of assets.
The key differences are that with a unit trust you actually own your portion of the assets in the fund, rather than owning shares in the fund. This subtle difference can be important. For instance, if someone wants to sell their shares in an investment trust they can simply find a buyer on the stock market. The assets involved are unaffected. If somebody wants to take their money out of a unit trust their portion of the assets would need to be sold in order to pay them, thus affecting the fund.
Secondly, an unlimited number of people can buy into a unit trust, whereas an investment unit only has a limited number of shares it will issue. A third and important difference is that managers of investment trusts can borrow money with which to invest. This could give you greater returns, as you’ll profit from risks the lender took, or it could mean your returns are eaten into by interest payments.
Above all else, the key thing to remember is that your portion of a unit trust is tied directly to the value of the assets your manager has amassed, whereas, in an investment trust, how valuable your share is will be decided by the demand of the stock market (which may not mirror the value of the assets you’ve bought into, as shares in investment funds are almost always sold at a ‘discount’ compared to their ‘true’ worth.)
As with investment trusts there are charges for buying and management fees.
Oeics (Open Ended Investment Companies) are the same as unit trusts in most of their major details. The biggest difference for consumers is how pricing works. With a unit trust there are always two prices: a buying price (bid) and a selling price (offer). The difference between the two is known as the spread. This spread has to be taken into account when reckoning up one’s gains or losses. With Oeics there is just one price that applies to both buyers and sellers.
With an index fund, the assets you invest in are not selected by a manager, rather they are put together automatically by tracking an index (such as the FTSE) comprised of the best performing stocks on the market. Some do this by buying into all companies in the index, other will go for a certain cross section.
A big advantage of doing things this way is that you will have lower ongoing costs as there’s no manager to pay. On top of this, when markets are rising these funds often do better than those that are actively managed.
One problem with ‘passive’ funds is that if a certain company or industry come to dominate the index then your risks are not spread as wide as they might be.
It’s always a good idea to start sooner rather than later when it comes to investing in a pension. You can get the ball rolling from the moment your grandchild is born by paying into a junior SIPP.
Up to £3,600 can be paid in each year, however, as the government pay tax relief of 20% of top of all contributions you only have to put in £2,880 to get the most out of a pension. The money is also free to grow without incurring income tax or CGT.
Of course, they will not be able to access the money until they reach 55, so if you are looking to provide help for key life events such as a wedding or buying a first home, you’ll need to go for a different vehicle.
As they will have to wait such a long time to get hold of the money you need to think about the potential consequences of making such a long term investment. For example, pension rules might change in that time, or you grandchildren may have no need of the money when they actually reach that age.
What’s The Most Tax Efficient Way To Save?
Finally, it’s helpful to understand the tax issues surrounding the way you go about putting your money aside as you want as much as possible to go to your kin rather than the taxman.
Children are subject to the same personal allowance as adults (£9,440 for the 2013/2014 tax year). As long as their total income does not exceed £100,000, then earnings below the personal allowance threshold are tax free.
However, different tax rules apply to the interest earned by children from accounts funded by their parents. Of this money only the first £100 is exempt from tax. Anything over this is taxed as part of the income of the contributing guardian (known as the ‘settlor’). You’ll need to include details of this income on your tax return using a SA107 form. (Note that each parent has a £100 allowance, meaning as much as £200 can be earned tax free.)
The good news is, this rule doesn’t apply to grandparents. You can give as much as you like and the interest it earns will not be taxed as part of your income.
In addition you have ‘gift allowances’ you can use. You can make small gifts of £250 a year which are tax free. There’s no limit to the amount of small gifts you can give as long as each recipient only gets one per year. So, if you have ten grandchildren you can give them all £250 a year without incurring tax.
You can also have an allowance of £3,000 a year for any gifts you make over £250 in value. You can even carry unused allowance from one year into the next (but no further).
You can give a grandchild a gift ‘on consideration of marriage’ (This is basically a gift given on the condition that they marry) of up to £2,500 tax free.
If you are planning on providing for your grandchildren after you’ve passed away, using these gifts can be more tax efficient that saving up a lump sum to bequeath in your will…
The Inheritance Tax threshold is £325,000 (this is set to rise to £329,000 by 2015.) Anything you leave behind you over this is taxed at 40% (or a lower rate of 36% if you give 10% of your estate to charity.)
If your estate is bigger than this and you are planning on using it as a way of funding your grandchildren’s future you should consider making canny use of your annual gift allowances to get them their money tax free.
If you have a spouse it is worth remembering that you can you can leave them any amount tax free and that any of the £325,000 that you don’t use will be passed to them. Effectively this means that you’d only need to worry about IHT if your combined estate is worth more than 650,000. Otherwise, splitting your estate so that neither of you are over the threshold is an easy way to avoid paying HTC.
If you do have a larger estate in can be prudent and highly cost effective to pay for tax advice to help rationalise your affairs. You should also make a will to ensure the way your money is left to whom you wish it to be and in the right proportions. If don’t have a will the funds will be allocated according to intestacy laws, which may not reflect your wishes and may well not be optimal tax-wise.
Capital Gains Tax
If you set up a trust containing assets such as shares or property, the trust may have to pay Capital Gains Tax should these be distributed from it. This will only apply if the assets have risen in value above the level of the ‘annual exempt amount’ (which is £11,000 for 2014/15).