Investing for Children - Part 1
In the last two articles, I have looked at investments, which are primarily for adults. This month, the ideas are for children. It is important to understand how the taxation of investments affects the parents or grandparents and children. As this is quite involved, I will be covering the topic in two parts. This month, I will deal with how the investments are held. Next month I will deal with the various types of investments.
Almost all parents invest for their children. Unfortunately, any investments are usually in cash accounts at a bank or building society offering low rates of interest. For years, life assurance companies and investment companies have advertised, trying to extol the virtues of holding part of the investment in equity related products. This advertising has failed to convince those who have had no previous experience of investing in the stockmarket.
To counter this perceived problem, the Government has committed itself to setting up a child trust fund for every newborn child in the country within the lifetime of this parliament. The child trust fund, or baby bond as it has been dubbed, will be introduced in 2003 to “extend the savings habit to more people”, according to the Labour Party’s 2001 manifesto. Exact details of the scheme are, as yet, not completed, so perhaps we can look at that in a later article. The child trust fund will soon be just the latest way for parents to save for their children.
Before trying to match the features of a particular product with the requirements of either parents or children, it is worth considering the use of a suitable trust. Whenever an individual wants to give one or more other people a lump sum, but does not want them to have the freedom to spend it, some form of trust will have to be used. The lump sum is gifted to the trust, meaning that it passes out of the possession of the individual making the gift. That individual, also known as the settlor in trust planning jargon, has no future influence over the assets in the trust, which eventually become the property of the designated beneficiaries.
When trusts are used to hold investments on behalf of children, the settlor will usually be either the grandparents or parents and the beneficiaries will be either the grandchildren or children.
There are many different types of trust wording available for parents and other relatives who want to save for children. However, in all but a few cases, one of the four basic types of trusts will meet the financial requirements of both the settlor and the beneficiaries.
Bare trusts and Accumulation and Maintenance (A&M) trusts are likely to be the most suitable types of trusts. This is because the beneficiaries have absolute entitlement to the contents of the trust at age 18 and either 21 or 25 respectively. The other two basic types of trust are interest in possession trusts, where income is paid to one or more beneficiaries, and discretionary trusts, which give the trustees the discretion to decide who gets what and when. The table below shows the main features of the two trusts that would normally be used.
Bare Trusts | A & M Trusts | |
| Age of absolute entitlement | 18 | 25 for trusts written after child reaches 4, 21 for trusts written before child reaches 4 |
| Trustees | Not needed | Appointed by settlor |
| Mixed beneficiaries | Yes | Cannot mix children and grandchildren in same trust |
| Unborn beneficiaries | No | Yes, so long as there is one living beneficiary |
| Restrictions on settlor | None | Must be single grandparent or one or more grandchild |
| Capital gains tax liability | Falls at beneficiary’s rate at age 18 | Trust has a CGT allowance of £3,750 pa, but if this is used the trust looses taper relief |
| Inheritance Tax Liability | None | Gift into trust is a potentially exempt transfer, so there will be no liability seven years after making the gift. * |
| Advances from the trust | No | The trustees can advance money at any time to the beneficiary before absolute entitlement |
| * IHT liability could also be avoided if the sum is less than the £3,000 annual gift exemption | ||
Advice on a suitable trust should be sought from your financial adviser, solicitor or your bank’s legal department. Next month I will look at different types of investments for children.
Back to article list