June 14, 2020
There’s something that I’ve always found a little bit hard to get comfortable with when thinking about saving for Z (my daughter). I’m comfortable with the money being in her name, but locking it up till she’s 18 has so far stopped me from opening up a JISA (junior ISA). What if there’s something that we want to use that money for earlier? School trips, private school fees, driving lessons/first car, music lessons? The list goes on.
These are all expensive things that happen before a kid turns 18, and they tend to be funded straight from a parent’s pockets — especially if all the money you’re saving for them has been locked into a JISA. This normally leaves 3 options;
I want to open your eyes to a fourth option that’s less well known, especially if you don’t have a financial adviser. A bare trust. I mentioned this in my last post but I want to go in to a bit more detail today and run you through some examples to bring it to life a bit more.
Very simply put, a bare trust is one where the beneficiary (your child in this case) has a right to all the money in the trust when they reach 18 but you can use it earlier — provided that it’s for their benefit.
The main difference (apart from the flexibility to use before 18) between this and a junior ISA is that the child has to pay capital gains tax and income tax.
Income tax is only relevant if the assets inside the trust are paying interest or dividends but you can get around that by making sure the assets are growth assets (i.e. don’t pay interest or dividends) or that any income made is reinvested in the portfolio.
I’m going to focus on capital gains tax to help me decide between a JISA (locked up till 18) and a general investment account wrapped in a bare trust (flexibility but potential tax implications).
Like us, children also have a capital gains tax (CGT) allowance each year. For this financial year (20/21) the allowance is £12,300. To keep things simple I’m going to assume that it stays at that figure for the next 18 years.
So this means your child only ever has to pay tax if they sell the investments and make over £12.3k profit in a single year. How likely this is to happen really depends on how much you’re saving for them each year and how much you withdraw in a given year. I’m going to run through some examples to show you that despite the investments being taxable, it takes extreme circumstances for a child to actually have to pay any tax on it.
You invest £100 a month and get 5% annual growth. In this example, your total balance would be around £30k by the time your child turns 18.
Your profit, however, would be just below £12.3k (the annual CGT allowance) even if you withdrew all the money in one go the year of your child’s 18th birthday.
My second example looks at what would happen if you invested £250 each month and benefited from 5% annual growth (this equates to investing £3k a year, the maximum “gift allowance” per year).
In this example you would only need to pay CGT if you sold all the assets at any age after 11. Waiting until your child’s 18th birthday would result in a profit well above the CGT allowance, as shown in the graph below, and a subsequent hefty tax bill.
For this reason it would make most sense to withdraw the money in chunks. The below graph shows a potential drawdown schedule, withdrawing £10k a year from 11–17 to contribute towards e.g. private school fees, and then taking the rest out at 18 to transfer to an ISA (or spend).
Let’s suppose however that you find you don’t actually need to withdraw any money for your child (hard to imagine, I know) and by the time they turn 16, you have a total balance of £80k in their trust. Instead of withdrawing all the money in one go, you can withdraw it in chunks between 16 and 18, transfer it to both a junior ISA and an adult ISA, and avoid paying CGT. This is possible as at the age of 16 a child can open an adult cash ISA as well as funding a junior ISA simultaneously.
By taking advantage of this and moving £20k into the adult ISA, and £9k into the junior ISA at the age of 16 and 17, and £20k in the adult ISA at the age of 18 and 19 you avoid paying any CGT at all and manage to transfer all the funds over to a tax efficient ISA by the age of 19.
As you can see a bare trust is an excellent option if you’re saving less than £3k a year. They offer basically the same benefits as a JISA (if structured properly), can be moved over to an adult ISA (with a bit of forward planning) and have the added flexibility that they can be withdrawn from to help cover some costs that benefit your child. Despite all this, they still remain unknown to most parents and under-utilised. We’re going to change that.
At Hapi we’re building a new savings & investment experience for parents. Just tell us what you’re saving for, and how much you’re looking to save, and we’ll come up with the right savings plan to help you get there, recommend the most suitable products for you, and then help you set up and manage them. One aspect of this will be democratising access to bare trusts and giving every parent the knowledge and benefit that only a minority of us have today.
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