You’d be forgiven for thinking that families don’t need to worry about paying tax on children’s savings; they’re just kids after all.
Although children won’t normally earn enough to start paying tax, a little-known rule means that if mum or dad saves on their behalf, they might end up paying tax on their interest. But that rule doesn’t apply to canny grandparents. Read on to find out when tax will be payable and how you can save the day.
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When it comes to tax, children aren’t treated that differently to their parents and grandparents. Like adults they’ve got a tax-free allowance (known as the personal allowance) which currently stands at £12,570 a year (and is frozen at that level until 2031).
If they are lucky enough to have an income that exceeds that, kids also benefit from a personal savings allowance. This lets basic-rate taxpayers enjoy £1,000 in savings interest before tax is charged, while higher-rate taxpayers can earn £500 in tax-free interest (additional-rate taxpayers don’t get a personal savings allowance).
You might think that, thanks to these allowances, the vast majority of children will not need to pay any tax.
Children might not be required to stump up any of their cash to HMRC, but there’s a little-known, but highly significant, rule that means parents could end up paying tax on their offspring’s savings interest.
You might hear this referred to as the ‘£100 rule’.
Adam French, head of consumer finance at Moneyfacts, explains: “Simply put, if a child earns more than £100 a year in interest from money gifted by a parent or step-parent, then all of that interest is taxed as the parent’s income, not the child’s.
“Importantly, it doesn’t just apply to the amount above £100,” he adds. “Once the threshold is breached, every penny of interest is treated as the parent’s for tax purposes, taking a substantial chunk out of their own personal savings allowance.”
If you end up exceeding your personal allowance, a tax charge will be payable.
The rule applies per child and per parent, per tax year. That means a child could earn up to £200 in savings interest before their parents need to pay tax, if they have two parents and contributions are split equally between them (for example are paid from a joint account).
Laura Suter, director of personal finance at investment platform AJ Bell, says that the idea is that the rule stops parents from attempting to shelter their savings from tax by holding them in their children’s accounts.
“It’s annoying that parents who have diligently saved for their children might find their good deed has a tax sting at the end of it. The limit is intended to stop parents funnelling their savings into accounts under their child’s name to avoid tax.
“But the £100 limit is out of date and should be increased to keep pace with inflation. This would prevent parents being caught out and having to report to HMRC for relatively small sums but would still act as a barrier to parents trying to tax dodge.”
With the top-paying children’s savings accounts paying around 5% interest, French says it would take a “sizeable, but not astronomical” sum to reach the £100 interest limit. “At 5% interest, £2,000 would generate £100 in interest over a year. For a two-parent household, that means £4,000 split evenly before the £100 rule becomes an issue.”
But French also points out this rule only applies to parents and step-parents. “Gifts from grandparents, other relatives, or friends don’t fall under it at all, which is where grandparents can become the heroes. By contributing directly to a grandchild’s savings account, grandparents can help boost a nest egg without triggering additional tax for the parents.”
There is also another way to save for children, that won’t incur any tax charges, irrespective of whether it’s parents or other family members that are contributing.
With a cash Junior ISA (JISA), interest earned won’t be taxable, so the £100 rule won’t apply. Suter says: “You can pay in up to £9,000 per child into a JISA each tax year, which means anyone who has built up decent savings outside an ISA can transfer up to that amount each year.”
A spokesperson for saving and investing platform Hargreaves Lansdown, adds: “One major benefit of the Junior ISA is that when they reach 18 it rolls over into being an adult ISA, so it keeps its tax-free status without you having to use your annual ISA allowance.” This wouldn’t apply if you were moving money out of an ordinary children’s savings account into an ISA. The catch is that children will have to wait before they can get the money.
“One major consideration is access, because the JISA is tied up to the age of 18, so if they want their children to be able to spend the money before then, they need to consider alternatives,” Hargreaves Lansdown adds.
It’s therefore those families that want their children to be able to access their savings before they turn 18, perhaps because they’re saving for expenses like a new phone or driving lessons, that a traditional children’s accounts will be the better bet, in spite of the £100 rule.
Whether you decide to pay money into a grandchild’s easy access savings account – to help them with their shorter-term financial goals – or help prepare them for adult life with contributions to their JISA, saving for younger generations can benefit you as well.
Lots of grandparents enjoy getting to see their grandchildren get the benefit of their wealth, while they’re still alive and their families need and appreciate their help.
But, as Adam French points out, a gifting plan can help cut a potential inheritance tax bill too. “Regular gifts made from surplus income can be exempt from IHT if they don’t affect day-to-day living.”
Or if you prefer to gift lump sums, you can gift £3,000 tax-free each year (either to one person or spread between several). You can also carry forward last year’s allowance, if you didn’t use it. That means a couple could potentially give away £12,000 tax-free in one year.
It’s also possible to make as many £250 gifts as you like (the small gift allowance), so long as each gift goes to different people and they haven’t benefited from any other gifting allowance. This could be a great top up for a children’s savings account, especially if you’ve got a lot of grandkids.
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