In his latest budget, George Osborne announced that from next April the rules on taxing savings would be changing dramatically. Basic rate taxpayers will be able to make up to £1,000 a year in interest on their savings before they have to pay income tax, for higher-rate taxpayers the interest limit is £500. But what does that mean for children?
Over the past ten years the government has encouraged parents to save for their children via tax-efficient vehicles. First there were child trust funds, then junior Isas (Jisas). With these their money could grow free from income tax, capital gains tax and most dividend tax, just like an adult Isa. But, if we can all earn masses of interest before we have to pay tax from next year is there any point bothering with Jisas?
It’s a question that has flummoxed Emma Sutterby, 35, a facilities faculty co-ordinator from Bristol. After the birth of their first son this month, Emma and her husband, Andrew, have been trying to work out the best way to start saving for his future. “There are so many choices and conflicting advice I’m completely baffled as to what to do for the best,” says Emma.
So, should the Sutterbys be putting baby Francis’s money into a Jisa? The overwhelming answer from industry experts is yes, for a number of reasons.
First, let’s look at cash Jisas. From next April we’ll all get the benfit of the new £1,000 savings allowance and the personal allowance of £10,800 that we can all earn (including children) before income tax is due. So it seems pointless bothering with a Jisa. But, parents still need to.
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This is because of the £100 rule. If parents deposit money into a non-Jisa children’s savings account and the interest earned amounts to more than £100 a year, then the interest will be taxed at the parents’ income rate. From next April this means that interest will count towards each parent’s £1,000 allowance.
“Although a child will have their own allowance, the £100 rule will still apply for monies gifted from parents,” says Susan Hannums, director of the independent savings adviser Savingschampion.co.uk. “While the rule is in place to deter parents from using the child’s account to shelter further funds from the taxman, those children who receive genuine gifts, in effect, are penalised.”
Another reason to stick with cash Jisas is the interest rates. “There is nothing to be lost by using a junior Isa [other than access before age 18] and often much to be gained as many banks and building societies offer better rates of return with a junior Isa than on children’s savings accounts,” says Danny Cox, head of communications at Hargreaves Lansdown.
The best cash Jisa rate available at the moment is from Halifax. It pays 4 per cent as long as a parent holds an adult Isa with Halifax. Otherwise, the Coventry and Nationwide are top of the picks, with each paying 3.25 per cent. By contrast, the best rate on a standard children’s savings account is 3 per cent.
However, given that the money new parents are putting aside for their children is likely to remain untouched for at least 18 years, putting it into a cash Jisa might be a bad idea. “Most children should be investing rather than saving, as over the long term this will provide a much better return,” says Cox.
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Over the past decade, the average cash savings account has paid about 3 per cent in interest, according to figures from the Bank of England. By contrast, the FTSE 100 is up 26 per cent over the same period.
“There is definitely still an important role for the junior Isa, as it allows you to invest in equities as well as cash,” says Ian Sayers, chief executive of the Association of Investment Companies. “Over time, this could build up a substantial sum: over the past 18 years, for example, a regular investment of £50 a month in the average investment company would have generated £27,812. That money would then be protected from capital gains tax and income tax.”
The new rules on taxing savings do mean that if you chose to invest for your child outside of a Jisa they would be able to earn up to £5,000 a year from dividends before tax was due, but they wouldn’t be protected from capital gains tax. It would be possible to avoid capital gains by using the child’s annual allowance to sell over a number of years but it does complicate things.
“Although next year’s tax allowances for interest and dividends open up some interesting investment possibilities for parents, many will still be drawn to the relative simplicity of Jisas,” says Stephen Berry, a chartered financial planner for NFU Mutual.
The main attraction of avoiding Jisas is control. With a Jisa the child gets access to the whole savings pot on their 18th birthday to do with as they wish. Many parents find this concerning as they hope to have built up quite a sizeable amount of money and worry that their teenage child could blow it.
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There are two ways to avoid this. You could either save the money in your own name and give it to the child when you think they can be trusted. This means that you’ll be eating into your own savings allowances and it can create inheritance tax issues. Alternatively, you could set up a discretionary trust to dictate that the child gets the money later in life. This is complicated and invokes different tax rules. So far, the statistics show that teenagers are being sensible.
“Our experience of maturing junior Isas is that the vast majority keep invested after age 18, with 71 per cent adding further savings,” says Mr Cox.
As for the Sutterbys, Emma has decided to stick with Jisas. “We aren’t planning to save more than the annual Jisa limit and if we put Francis’s savings into a Jisa I don’t have to worry about falling foul of complicated tax rules,” she says.
“Plus, I’m going to spend the next 18 years teaching him about the value of money so, hopefully, when he does get access to his savings pot, he’ll use it wisely.”