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The tooth fairy has got some serious competition when it comes to giving money to children. In the race to be generous, grandparents are leaving Tinkerbell eating fairy dust.
According to a report from Lloyds Bank, British grandparents collectively gave an eye-watering £5.6 billion to their grandchildren last year – and that was on top of £29.6 billion they lavished on their own children, equating to £753 for every adult in Britain.
Jason Hollands of investment and financial planning firm Tilney Bestinvest, is all for grandparents giving money to younger family members once the older person have secured their own needs. He says: “Grandparents are often key in providing financial support to their children, especially when you see the staggering levels of debts many kids start adult life with today thanks to education loans.
“But beyond the instinct to support their family, this can also make sense in reducing potential inheritance tax liabilities. After all, few of us would prefer to see our assets go to the taxman rather than our own family.”
How you give money will largely depend on the life-stage of your grandchild. Read on for tips on giving money to...
The best way to give cash to a child is to contribute to a Junior Individual Savings Account (Jisa). These are accounts, in either cash or stocks and shares, for children under the age of 18 that allow up to £4,080 a year (2015-16 allowance) to be set aside for a child in a tax-efficient way.
They are available from a wide range of providers including banks, building societies and asset managers – companies that manage stocks and shares.
Jason Hollands says: “Although a parent or legal guardian must open a Junior ISA, once open anyone can pay in. Here a bit of wisdom and experience from members of the older generation can also be valuable in helping to choose the investments, as well as hard cash contributions.”
HM Revenue & Customs data show that about 70% of Junior ISAs have gone into cash, which Mr Hollands calls “a dreadful place to save for the long term”. This is because even though stock market returns may fluctuate and even go down in the short term, cash returns are invariably much poorer in the long term, particularly in the current environment when interest rates are so low.
However although the general consensus is that shares will offer a better return over the medium to long term, of five years or more, how the child’s parents want to invest is a matter of personal preference.
Opening a stocks and shares account could not however be easier, so wondering how you do it should not be an obstacle. There’s more information here.
Further, cash ISAs will become less appealing from next April when the rules on tax free savings change (see below).
What about Child Trust Funds?
If you were wondering what happened to Child Trust Funds (CTFs) - a type of account similar to a Jisa - these are no longer available. CTFs, could be opened for children born between 1 September 2002 and 2 January 2011 but they have now been discontinued and no new accounts can be started. However, those children who already have CTFs will retain them until they reach 18, and contributions can still be added to them.
The CTF and Jisa rules have been aligned and CTFs have the same contribution limits as Jisas. The good news is that parents can switch existing CTFs into a Jisa if they believe this will give them a better return – and Jisas often do as they offer a wider range of investment choices.
If your grandchildren have CTFs you could investigate if they might be better off with a Jisa and nudge their parents to make the switch.
There’s more information on Junior ISAs and how to switch from a Child Trust Fund on the Money Advice Service website.
Once the Junior ISA is maxed out, or if you have smaller sums to invest, grandparents could consider National Savings and Investment products, such as Children’s Bonds and Premium Bonds, Grandparents can buy these themselves for grandchildren or great-grandchildren under 16, and they can be held in the buyer’s name until the child’s 16th birthday.
You are unlikely to be able to open a bank or building society savings account for a child unless you are the child’s legal guardian. But grandparents can pay into a savings account once a parent has opened it.
Children have their own tax allowance (£10,600 in the current tax year), and if the parent fills in form R85 (available from the bank or building society) interest can be paid without tax taken off.
From next April 2016, the rules on savings are changing. Interest on ordinary bank and building societies will be paid gross, so you won’t have to bother with form R85 and the return on the first £1,000 a year will be tax free for non- and basic rate taxpayers.
Because the annual tax allowance is rising to £10,800 from next April, a child will be able to receive £11,800 tax free - as long as it does not come from their parents.
When giving larger sums of money to a child, grandparents and friends should try to make sure it goes straight into the child’s account rather than being paid over to a parent. Alternatively, you should provide documentation of the gift. This is because, if a financial gift derives from a child’s own parent and the interest comes to more than £100 a year, tax is charged as if the money belonged to the parent. You should therefore always make sure the taxman can see where the money has come from.
Read more on the rules about giving money to children.
It may seem odd, but a child can have a pension plan from birth – and contributions from grandparents could lay the foundation for making the child a pension millionaire before they even leave school.
Pension saving for a child is probably your least urgent priority as there are bound to be more urgent demands on your cash, such as holidays, education fees, buying a car or a deposit for a home, but if you have done all that, pension saving for a child is amazingly tax efficient.
Pension contributions are normally pegged to earnings because of the tax relief they attract. The rules state, however, that anyone – even a child – can contribute up to £3,600 a year into a pension even if they have no earnings at all. Even better, contributions still attract tax relief, meaning that the £3,600 contribution costs just £2,880.
Tilney Bestinvest’s Jason Hollands says: “Of course none of us know whether this £3,600 gross allowance will increase, decrease or disappear in the future but an annual contribution of £2,880 for 18 years would represent an outlay of £51,840. If the tax treatment remained constant, these contributions would be grossed up to £64,800.
“If this sum continued to return at an average rate of 5% per annum, by the time the grandchild turned 65 the fund would have grown to £1.15 million – and that’s before they, or their future employers, put any money aside.”
So in other words, your contributions until the child turns 18 could ensure they had a reasonable pension by the time they retired even if they never paid a penny themselves during their working life. If they saved for retirement themselves as well they could end up stinking rich!
Helping with school fees is an ideal way for grandparents to help out, and can even reduce inheritance tax if you use the “regular gifts out of income” exemption. Even if you don’t live for seven years after making the fee payments, as long as there is a commitment to pay fees on a regular basis the gifts will be IHT-free.
Grandparents can also help with pocket money or picking up a regular expense, such as a mobile phone contract. But do be careful what you are signing up for. If the child decides to stream a television show on their smartphone during a foreign holiday, and runs up a bill for £1,000, it will be down to you to pay it as the account will be in your name.
Read more about gifting money to your children.
Many grandparents want to help out with their grandchildren’s student loan repayments, but you should be careful that you aren’t throwing money away. Student debt repayments are “income contingent” and work more like a tax on earnings than – say – the repayment of a mortgage, where overpayments can reduce the monthly bill. Moreover, if the student never earns enough for the debt to be paid in full, the remainder owing is written off after a certain period.
There’s plenty of information on the Student Loan Repayment website about how student loan repayments work. In short, unless you are sure that your grandchild will have earnings during their working lifetime that will repay their loan in full, you could be wasting your money by repaying debt that would otherwise have been written off.
For students who are unlikely to be among the highest potential earners, the best way to help them could be to contribute towards the cost of accommodation, or by paying down credit card debt or a bank overdraft instead.
Helping with rent and house purchases are top of the list. Parents and grandparents have traditionally downsized to release money to help family members get on the property ladder, and save inheritance tax too by reducing their assets before they die.
The inheritance tax rules are changing to take family homes worth up to £1 million out of the IHT net so the older generation may be less incentivised to move. However, where grandparents are moving to a smaller home anyway, handing surplus cash over to the younger generation can still make sense.
What about Help To Buy ISAs?
A new scheme to help young people to buy their first home is the Help to Buy ISA, which was launched in December 2015. The HTB ISA is an alternative form of cash ISA and will be available until 2019 to over-16s who haven’t opened another ISA in the same tax year.
You can make an initial deposit of £1,000, then normal monthly savings of up to £200 a month for the next four years. The Government then tops up the account by an extra 25% of the amount saved, the equivalent of receiving basic rate tax relief on your savings, up to maximum of £3,000 per person, The minimum amount you need to save to qualify for a bonus is £1,600 (which gives you a £400 bonus).
The bonus is available on home purchases of up to £450,000 in London and up to £250,000 outside London and will be handed over when the young person buys their first home. The bonus is paid straight to the mortgage lender, it earns no interest, and you only get it if you buy a home.
The limit on HTB ISAs is much lower than for an ordinary ISA and the money must be spent on a home within a certain price band, so it is not very flexible. However, the bonus rate is highly advantageous and should certainly be considered by anyone likely to be buying a first home within the time frame.
Read more about Help To Buy ISAs.
Find out more about signing property over to your children.
Grandparents who want to help young adults financially without actually handing over cash may be able to act as a guarantor for a grandchild’s home loan. There are several ways of doing this, usually by depositing cash in a savings account with the mortgage lender, or putting up their own home as security for the grandchild’s loan.
A guarantor loan could be particularly suitable where the home buyer can “afford” higher mortgage payments, perhaps from bonus or commission payments, but the lender will take account only of basic salary when calculating the size of the loan it is prepared to advance.
The advantage of guaranteeing a loan is that no money changes hands to set the arrangement up. The downside is that, if the grandchild defaults on payments, the lender can recover the money by seizing the savings account, or even forcing a sale of the grandparents’ house
Grandparents can also participate in so-called “offset” arrangements. The grandparent places cash in a savings account with the mortgage lender, and interest on the savings account, instead of going to the grandparent, is deducted from the sum the grandchild needs to pay for the home loan. Because the grandparent receives no interest, as it is diverted to the mortgage, there is no income tax to pay, making the arrangement highly tax-efficient.
If a grandchild lives overseas permanently, consider how the child will eventually access the cash. It could be better to send money to the parents and lodge it in an overseas account that they set up for the child.
If you must save in the UK, you will meet the same obstruction to opening an account for a child living abroad as you do for one living in the UK – in fact probably more so. Even a parent who lives abroad may not succeed in opening a UK account for their child unless they have a permanent UK address, because of money-laundering rules. For small sums, National Savings products that allow investments for overseas residents may be your only option.
Don’t open accounts without telling parents and guardians what you have done. Accounts that are tax-free in the UK may attract tax in other financial jurisdictions – including many US states – or you may inadvertently cause parents to breach account investment limits. A “secret” account could actually put the child or his parents in breach of the law.
Will you need to pay tax?
You can give grandchildren as much money as you like with no immediate tax implications, as there is no tax in the UK such as a capital transfer tax, on gifted transfers of money between individuals.
Yes, really. People worry that there is an “allowance” that they must not exceed each year, but it’s not true.
The main thing you DO need to watch out for is inheritance tax (IHT), because some lifetime gifts can be included in your estate. IHT can be a complicated area, so if you have concerns, take professional advice.
If your estate is small – below £325,000 – you have no IHT worries. Neither should you worry if you live seven years after making the gift. You really can give away as much as you like tax-free, as long as you survive.
You can give away assorted smaller gifts (see below) and even if you are relatively wealthy and are likely to have to pay IHT on some of your estates, the “gifts out of income” is a really useful allowance. You can make regular payments – for instance for school fees or into an insurance policy or a child’s pension plan – and the money you hand over is free of inheritance tax even if you don’t survive for seven years after handing the money over. The only stipulation is that the payments don’t eat into your capital and they don’t reduce your standard of living.
You pay no inheritance tax:
- If your estate is below the current nil rate band (currently £325,000 per person or £650,000 for a spouse whose partner has predeceased them and not used any of their own allowance themselves).
- On gifts made seven years or more before death.
- On gifts within your annual allowance (currently £3,000).
- On small gifts that amount to no more than £250 each within a year.
- On gifts on the occasion of marriage (subject to limits).
- On regular gifts out of your ordinary income that do not diminish your capital or reduce your standard of living.
Read more about being taxed on the money you give to your children.
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