Junior ISAs

There's a common myth that children don't pay tax - that's simply not true. In fact, they're taxed in exactly the same way as adults; which means that in the tax year 2012/12 each child can earn up to £7,475 tax free from earnings, savings or investments. The difference is, unlike most adults, the majority of children don't use up their Personal Allowance, so their savings interest remains tax free.

Saving for children ticks boxes all round. Parents and grandparents often like to build up a nest egg to help with future expenses, such as university fees, a first car or the deposit for a first home.

Although saving for children is seen as positive, a stumbling block has always been that the tax authorities did not want parents to use their children's accounts as a means of avoiding paying tax.

Where money given by a parent or step-parent to a child produces a gross income of more than £100 a year, the parent or step-parent becomes liable for tax on all the income in excess of £100. Even in today's low interest rate environment, relatively modest levels of savings could trigger tax payments.

This is where a new, tax efficient method of saving for children, launched late last year – the Junior ISA comes in. This effectively replaces the Child Trust Fund (CTF) system which, since it came into being in 2003, was one of the Government’s flagship savings vehicles.

The Junior ISA gets round the tax rules relating to money given by parents by forcing the parent to give up control of the money. No withdrawals are permitted until the child reaches the age of 18, by which time it is legally the child’s money. Whilst having no access until age 18 may have its drawbacks, it does foster a long term, tax-efficient saving method for the child.

All children under the age of 18 who did not qualify for a Child Trust Fund are able to open a Junior ISA, but unlike the CTF, there is no government contribution to kick-start the plan.

Anyone, the child, family or even friends can pay money in to a Junior ISA, up to a maximum level of £3,600 per tax year.

Income produced or investment returns generated by the Junior ISA do not count towards the child’s personal tax allowance - effectively meaning any income or capital growth can roll up tax free.

Like the ‘grown up’ versions of ISAs which have been in place for many years, Junior ISAs can invest in cash, or investment versions that use stocks and shares, bonds, investment funds etc. It is also possible to split across both.

Cash may be seen as less risky, but there is always the danger that inflation will erode its spending power over long time periods. Stocks and shares have historically outperformed cash over the longer term, but can be more volatile leading to fluctuations in capital value and creating the potential for capital loss.

Within this arena there are many different investment solutions to choose from; some investing in low-cost funds that simply track a stock market index, some in more actively managed funds that try to pick good underlying investments and other  more niche areas, such as ethical investments.

Where Junior ISAs could really deliver benefits though, is in helping to educate children financially and going some way to creating a new saving focused mind-set in the young. Who knows, this may help prevent their generation making some of the financial mistakes of those before them?

Nathan Glaister
Financial Planning Consultant

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