Investing for the next generation: when control trumps taxes

Kids are a pain. One minute you’re funding their entire lifestyle. The next minute they’re off to university or buying their first flat – and you’re still funding their entire lifestyle.

But perhaps you want to do even more for the young people in your life?

Maybe you want to help give your little ones (another) leg up?

Maybe your genes are forcing your hand!

You’re not alone. Almost £10bn has been socked away in Junior ISAs (JISAs) for the benefit of children, for example, according to AJ Bell.

That’s equivalent to 1.25 million JISA accounts – or roughly one for every ten kids in Britain. Although in reality some lucky children will have multiple accounts, like mine.

Do my kids appreciate this foresight and generosity? Well one thinks everything costs £20 and the other prefers eating coins to using them. So we aren’t quite there yet.

And this hints at the crux of the issue – children are, well, children. They don’t think in the same way as hardbitten Monevator-reading adults.

Which is charming enough when you’re on a trip to Disneyland and they still think Mickey Mouse is real.

But it could be somewhat less heartwarming if they blow half the money you saved for them on a bender in Ibiza the day they turn 18.

We’re spoilt for choice when investing for kids

The first thing to say is that parents have many options when saving for their children.

Easy does it: standard cash and investing accounts

Obviously you can put cash straight into a child’s bank account. Depending on their age and the bank in question, you can then control withdrawals. ¹

Children can also hold shares and funds via designated or bare trust accounts.

In all these cases, by the time the child turns 18 they typically gain control and with it the ability to withdraw all of the cash and shares.

But just shoving money into a standard account like this isn’t ideal, because once a child earns over £100 in interest from parental gifts, their interest is taxed as if it was earned by the parent. The same thing applies if you buy shares for them, too.

Not surprising really, given what an easy tax-dodge little Junior would otherwise be.

If it’s not your child, though – perhaps a grandchild – crack on!

I’m sure some of you have spotted some potential loopholes in these rules. But the spicy boundary between tax avoidance, mitigation, and evasion isn’t on my agenda today.

The tax-efficient route: JISAs, JSIPPs, and Premium Bonds

Want your kids to invest more tax efficiently without the risk of only seeing a parent during whatever visiting hours His Majesty’s Prison Service finds convenient?

Fortunately you have several options.

Junior ISAs

The aforementioned Junior ISA (JISA) is the most common way to save for kids. JISAs enable a child to save or invest up to £9,000 per year shielded from income tax and capital gains tax – so just like an adult’s ISA, only with lower contribution limits.

Junior SIPPs

Alternatively, an option that seems to be growing in popularity are Junior SIPPs (JSIPPs).

A JSIPP lets you get a child’s pension rolling, decades before most of their peers will ever hear the word. A child is allowed contributions of up to £3,600 gross (£2,880 net) per year. A 20-year head start on a pension will certainly turbocharge the compounding process.

Premium Bonds

Finally, you could buy them some Premium Bonds like everyone’s granny used to do. Winnings are tax-free, and so Premium Bonds are one of the easiest ways to put aside tens of thousands in cash for your children in a tax-efficient manner.

Also, unlike with a JISA or JSIPP, if your family wants to use some of the child’s money before they turn 18, Premium Bonds give you that option.

The complicated route: trusts

To retain a degree of control you could consider a discretionary trust.

Trusts enable you to define how the assets should be used, even after the children turn 18. They are often used for large legal settlements, or where relatives pass away leaving six-figure amounts that need careful management.

Beware though that trusts come in various shapes and sizes. The tax rules are complicated, and you will need expert advice to get the most out of them. If you’re a typical saver who just wants to save a few thousand pounds for a child – or even a few tens of thousands – then the complexity and cost will probably outweigh the benefits.

• See our Mogul member’s article on discretionary trusts.

The hold-it-yourself route

Keeping hold of the cash or assets yourself – rather than giving it to the kids – is the simplest option.

But I know it possibly sounds like the stupidest option, too.

Why waste the £9,000 per year tax-free allowance of a JISA? Or spurn the £3,600 per year JSIPP allowance – which could compound for 70 or 80 years to deliver a healthy pension? (Assuming the government in the 22nd Century allows your kids to retire before they’re 100.)

Why indeed?

Well, I think there are some advantages that I’ll get on to in a minute. But first a recap.

Investing for future generations: your options at-a-glance

Strategy	Age child gains control	Tax benefits	Cost of administration
Put cash into a child’s bank account	18, though many banks will give partial control earlier	If cash didn’t come from a parent, child can use standard £12,570 Income Tax allowance	None
Buy shares in a child’s name via a bare trust	18 (16 in Scotland)	If cash didn’t come from a parent, child can use standard Income Tax and CGT allowances	Low, though few brokers advertise this option. See AJ Bell or Hargreaves Lansdown
Open a Junior ISA (JISA)	16, but can’t withdraw until 18	Shielded from capital gains and income tax, transforms into an ISA	Low, see our broker table
Open a Junior SIPP (JSIPP)	18, but can’t withdraw until 57	Shielded from Capital Gains, Income Tax payable on withdrawal, transforms into a SIPP	Low, see our broker table
Buy Premium Bonds for a child	16	Untaxed	None
Set up a discretionary trust	Trust retains control	Trusts are taxable, rules are complicated	Set-up can exceed £1,000. Expect to pay annual management fees
Hold assets in your own name	Adult retains control	None, unless you use your own ISA allowance	Negligible, assuming you have existing accounts

It’s about psychology, not money

The real issue isn’t tax efficiency though – it’s psychology.

I was fortunate to start university with a few thousand pounds which my grandparents had invested into a cautious investment trust.

I’d also worked part-time since turning 17 and I’d saved some of my earnings there, too.

Moreover even at that age I was enamoured with compounding my money. (Perhaps excessively, but that’s a story for another day.)

So you can imagine the shock I had on seeing my fellow students gleefully burning through the free £500 overdrafts being doled out by the High Street banks.

This difference in our mindsets was driven home when I found myself lending £100 to one friend – a recent graduate from a particularly posh boarding school – who was unable to afford a train ticket home for Christmas. He’d squandered his allowance!

I can only imagine the carnage if everyone had hit Uni with six-figures in savings to burn.

More recently, I was consoling a somewhat glum colleague about his son’s JISA.

Oh, the investments he’d made were doing well. The snag was that his son had recently observed that the JISA balance could buy a brand new BMW i8…

The Ins but not the Outs of JISAs

You can manage a JISA for a child and make any number of astute decisions on their behalf. But the only way the money can leave the JISA is after the child turns 18.

And at that point, in an instant, the child (now adult) has full control.

True, you might have a mature and financially-astute child who continues to manage the pot carefully and industriously.

But then again, you might not.

What if you twig when they’re 16 that getting access to all this money is going to be a disaster? Well, you’re out of luck. It’s going to them whether you like it or not.

If I pointed out that a young person might blow the lot on alcohol and a sports car and find themselves wrapped around a tree at 3am, I might be over-egging the case.

But you cannot expect the average 18-year-old to spend in the way you’d like them to. 

Nor can you tell when they are three, eight or eleven-years-old whether your have a child that’s out of the ordinary in this respect.

Is a pension the answer?

I’m equally sceptical of JSIPPs – although for a different reason.

If we consider the big challenges facing young people today, student loans and high house prices loom large.

Scraping together the deposit on my first home was a goal I’d worked at from the age of 17. It took a lot of hard work and, ahem, frugalism.

And I’m not sure as I was striving away how much I’d have appreciated knowing my grandparents had put money away for me… to access in the year 2065.

I don’t think that I’d have been ungracious!

But given that the start of someone’s financial life is typically when things are toughest, you might be doing a child a disservice by ring-fencing money for some far-off future when they’ll be grey-haired, or maybe not even alive anymore to spend it.

Why I would choose the suboptimal option

Personally, if either parent has space in their own ISA allowances, I would encourage hiving off a segment of that for your children before you open a JISA.

You can pay them lump sums from this allocated money as needed in their future.

By retaining the money in your own accounts, you have full control of it. And you don’t burden your kids with needing to make good decisions when they’ve only just become old enough to legally drink.

Now, you may be gnashing your teeth here. And I too usually prefer financial arguments to psychological ones.

If investing typically results in a higher return than paying down a mortgage, say, then investing is what I’ll prioritise.

But when you’re making money decisions for other people, you need to think broadly.

It’s like how some debt specialists advise people to pay off small quantity debts before high-interest ones. They know that psychologically the person with debt may be more motivated by seeing small debt balances disappear completely – even if financially it’s nonsensical to pay down anything but the debts with the highest interest rates first.

Getting people in debt to keep getting out of it will always beat the strategy they give up on.

Taxes might sting

If you do feel able to allocate some of your ISA allowance to your children, all good.

However what if both parents are already making full use of their ISA allowances?

Well, investing outside of tax wrappers brings with it the potential for dividend tax at up to 39.35% and capital gains tax at up to 24%.

And that’s clearly the main disadvantage of foregoing the JISA or JSIPP route.

There are a few ways you can try to minimise the tax drag:

• Use your ISAs for your equity holdings and hold your tax-advantaged gilts outside
• Harvest capital gains in your taxable accounts each year
• Encouraging relatives to keep money in their own name rather than handing it over to you immediately. (Though this comes with obvious issues, too. And don’t forget inheritance tax!)

There’s no way around it for some parents though – they will inevitably have to choose between going with JISAs and JSIPPs or else paying taxes.

As I say, I’m sceptical JISAs and JSIPPs are the no-brainer many people seem to think. So I’d be prepared to pay some tax to keep control.

But if you specialise in risk quantification and you want to have a stab at telling me whether my kids will be a decent bet by the time they turn 18, let me know in the comments.

Am I a hypocrite?

The observant of you may have noted in the introduction that I mentioned holding multiple JISAs for my children.

And that’s true. You see, I’ve decided it’s reasonable for my children to access modest four-figure sums when they turn 18.

If they choose to blow that money when they get access that’s their prerogative – and potentially a clue as to how I should disburse their remaining money.

I’ve only invested a small amount upfront in these JISAs, and have made some rough projections based on historical data. I’ll top-up the accounts in the future if necessary. 

For example I’ll want to roughly equalise what each child gets, after sequence of returns boosts or depresses their final totals. (This may seem tantamount to communism, but it feels fair to me…)

The rest of the money earmarked for them will sit with us as parents and grandparents. Then when the time is right – perhaps for a house or a car – we’ll be able to support them.

But until then they need never know that this money is even there.

I should stress the kids’ assets will be clearly delineated in my accounting from my own investments and retirement funds. And as I said, I’m an addict for saving for the long-term.

However if this approach would present too tempting a pot for either adult to dip into from time to time, then clearly JISAs or JSIPPs might be a better option.

There will always be risks

Who knows what world our children will inherit as adults?

Should we consider the risk that they start adulthood with a period of unemployment? Or suffering from health issues that prevent them from working?

Under the current rules, having just £16,000 of savings would make them ineligible for means-tested benefits like Universal Credit.

We can debate the politics of that endlessly. My point is even a well-managed portfolio could be soon burned through for very little benefit.

Similarly, what if your child meets a malicious lover who systematically extracts their cash before moving on? You might regret having put a six-figure target on their backs.

I once spoke to a guy at a firm who specialised in inter-generational wealth for ultra high-net-worth families. I asked him what his customers valued that might surprise me?

“Teaching their little [bleeps] how not to piss away the family fortune,” he replied.

Maybe that’s too cynical. The whole point of saving money this way for the future is to help our children – or other young people we dote on – to achieve their dreams.

We can’t protect them from everything. But we can make their path a little easier.

Are you putting money aside for your kids or grandkids? Did your elders do the same for you? Let us know how and why in the comments below!

1. The rules here can be very complicated. For example Santander’s 123 Mini can be managed by a trustee until the child is 18, but not if the child is 13 or older when the account is opened.[↩]