The main aim of investing for your child is to provide them with a decent nest egg for the future, so they can live their life on their own terms. But if you want to offer them the best future possible, it’s important to consider the impact tax could have on their potential profits. Here’s a few things to consider if you want to invest in your child’s future.
Do children pay tax?
It’s not always well-known, but children may have to pay tax if they earn income or returns from investments over a certain threshold. Typically, most children can earn up to £18,500 per year without having to pay tax, anything above will be subject to income tax – this is their tax-free allowance for the 2022/23 tax year and it’s broken into three areas:
- A personal allowance of £12,570
- A personal savings allowance of up to £1,000 and
- A starting rate for savings of up to £5,000
The full starting rate for savings will only be available if your child’s income, excluding savings income, is less than £12,570. If this ‘other income’ is above £12,500, then for every £1 above the limit, your child will lose £1 of the starting rate for savings1. However, if this ‘other income’ includes dividends (payments made by a company to its investors), then your child could benefit from a tax-free dividend allowance of £2,0002.
But it doesn’t stop there. Your child may also need to pay capital gains tax if their total gains for the year were to exceed £12,300 for 2022/233.
Finally, if your child earns more than £100 in interest from money you’ve given them (or £200 if both parents give money), then you’ll need to let HMRC know, and you, as a parent or legal guardian, will need to pay tax on any interest that is earned over £100. This doesn’t apply to money given by grandparents, friends, or relatives4.
Why might tax matter?
When saving and investing for your little one, you may want to keep an eye on the amount of tax that would be owed as this will eat into your child's returns (such as interest earned on savings or dividends from investing) – meaning it could reduce how much your child ends up with at the end of their saving or investment journey.
After all, the more tax your child has to pay, the smaller their final savings pot will be, so you may be someone who wants to prioritise keeping this at a minimum.
Things to consider when investing for your child
One way to invest for your child is to pay into a Junior ISA (JISA). A Junior ISA, or a Child ISA, is a type of account that lets you put money aside for your kid in a tax-efficient way. In other words, with a Junior ISA, your child doesn’t need to pay tax on any profits they make, meaning they can keep more of their potential returns
In total, there are two types of Junior ISA. First, you’ve got Junior Cash ISAs which are basically cash savings accounts that pay tax-free interest to your child. Then, you have Junior Stocks and Shares ISAs which let you invest for your kid in a tax-efficient way. But unlike Adult ISAs where you can open a new account every tax year, your child can only have one Junior Cash ISA, one Junior Stocks and Shares ISA, or one of each. Typically, Junior Cash ISAs are relatively safer than Junior Stocks and Shares ISAs as your child is guaranteed to receive interest and see their money grow. However, with a Junior Stocks and Shares ISA, returns aren’t guaranteed, and there’s a risk they could end up with less than you initially put – that’s something to be aware of before committing to this type of account.
Junior ISAs come with an annual allowance. Currently, your child’s ISA allowance is £9,000 (subject to change). This means £9,000 is the maximum amount you can put in a Junior ISA within a tax-year. Compared to the previous tax year’s limit, this marks a significant increase. The Junior ISA allowance for 2019/2020 was set at £4,368, and in 2018/19, your kid’s ISA limit was just £4,260. In two years, the JISA annual allowance more than doubled!
Sadly, you can’t carry over any unused allowance into the following tax year. Your child's ISA allowance must be used before midnight on the 5th April, otherwise, it’ll be lost forever.
The good thing about Junior ISAs is that everything you put in is locked away. Nobody, not even you, can dip into your child’s pot, giving your kid’s money a better chance to grow. Your child will get full control over their account when they turn 18. The money will be theirs, and they’ll be able to decide what to do with it, whether it’s withdrawing some or all of it, or converting their Junior ISA into an Adult ISA to maximise their savings.
How to open a Junior Stocks and Shares ISA
If you want to invest for your child in a tax-efficient way, then opening a Junior Stocks and Shares ISA could be a great place to start. But how does it work? Well, with robo-investing platforms, like Wealthify, setting up a Junior ISA is very easy. All you need to do is let us know how old your child is – you can start as soon as your little one is born. Then, simply choose how much you’d like to invest and select the risk level you’re comfortable with. We’ll do the rest, from building your child’s investment Plan to managing it on an ongoing basis.
References:
2: https://www.gov.uk/tax-on-dividends
4: https://www.gov.uk/savings-for-children
The tax treatment depends on your individual circumstances and may be subject to change in the future.
Please remember that the value of your investments can go down as well as up, so with a Junior Stocks and Shares ISA, your child could get back less than what was invested.
