Gifting money to children and grandchildren

Investing for children

I have had many conversations with parents and grandparents about investing a lump sum or starting a regular savings plan for their children and grandchildren (under 18’s). In the end, even with several options on the table, rarely do they proceed. It’s like none of the options fit the bill perfectly and the idea loses momentum. 

If I reflect, most do not like the idea of the child having access to a large sum of money on their 18th birthday. We have this common fear that our children will suddenly turn into a party animal and waste the money on fast cars and Rolex watches. 

From our experience, when such savings do mature and your child hits 18 (or 21) and learns that they now own a chunky sum of money, they aren’t immediately ordering the Ferrari. They are actually very grateful and start to take a real interest in how to manage the fund going forward. Your child doesn’t get taught about savings and investments at school. Having the responsibility of managing their newfound wealth means they often seek out how best to look after this amazing gift.  

Let’s now look at the gifting options available, from the simplest to the more complex. I ask you to be brave. Have faith that your parenting and grandparenting skills have worked, and they won’t blow the money on fast living at the earliest opportunity. You probably do not need the complex, protective arrangements after all.

A simple gift

An outright gift is the easiest way to do things if the money is staying in cash or will be used in the near term. It is a good option if the child is old enough and has the financial maturity to manage the money. They can put it in their bank account, National Savings or Junior ISA and earn an interest. 

There is one small risk warning with a simple gift – the parental settlement. If parents make gifts for their minor child, they may continue to be assessable for any income which arises from the gift. If income exceeds £100 each year, then the whole amount will be taxed as the parent’s. This limit is per parent, per child.

This tax rule does not apply where grandparents make a gift though.

Junior ISAs

Parents and grandparents can contribute to a Junior ISA. The annual subscription limit is currently £9,000 (2023/24). This allows the money to grow free from income tax and capital gains tax. As a bonus, Junior ISAs do not pay tax on gifts from parents as the parental settlement tax rule does not apply.

If the annual subscription is paid each year from surplus income, the gifts may be immediately outside the estate for inheritance tax.

A Junior ISA can be invested in cash (as a tax-free bank account) or it can be invested in investment funds for potentially higher returns. The Junior ISA is effectively managed by the parent until the child reaches 18 so this makes for a good long term investment option. 

The child has access to the ISA and therefore the money at age 18. The Junior ISA converts to an (adult) ISA, and they take control and ownership of the money. 

In our experience attaining 18 hasn’t been detrimental to the investment. The child invariably steps up and looks forward to managing it themselves, often with our guidance. I can only say that is good thing. 

How about investing but keeping the money in your control?

You really can’t beat the simplicity of a straightforward gift or a gift into a Junior-ISA. However, if your child or grandchild isn’t sufficiently mature enough to self-manage the money themselves, or you don’t want them having access at age 18, you can set up a savings or investment plan in your name and ear mark the funds for their future. This keeps things easy and flexible for you. 

As you still own the money you may have tax to pay on the income and growth and it doesn’t help reduce your inheritance tax, but you chose when the money is released.  

Designated accounts – some unit trusts and OEICs offer designated accounts. This allows an investment to be set up in the name of a parent or grandparent, but the fund is earmarked or designated for a particular child or grandchild. 

But what about trusts, I hear you say. Shouldn’t I have one of those instead?

Gifting money using a trust is a way of keeping things flexible, having more control over the money before it is distributed to the beneficiaries, and it can be inheritance tax efficient. 

Making gifts to a trust can allow the trustees to appoint money to the beneficiaries at the appropriate time and it prevents the child from being able to dip into their savings early. 

When setting up a trust there are a few things to consider.

  • What type of trust would best meet your objectives? 
  • Who do you want to benefit from the trust fund?
  • Who shall you appoint as the trustees?
  • How would you like the money invested?
  • How much will it cost to set up and manage?
  • The trust will need to be registered with the Trust Registration Service.
  • The trust may need to submit annual tax returns. 
  • Who will pay any tax? 

A Bare trust or absolute trust is the simplest form of trust. You name the beneficiary at outset in the trust document. The named beneficiary(ies) cannot be changed, and future children or grandchildren can’t be added once the trust is set up.

The beneficiary has a right to both the capital in the trust and any income generated from it. They will be taxed on any income and gains unless the parental settlements rule applies. Income can be offset against the child’s personal allowance and capital gains against their annual exemption. 

The trustees do not have to pay out once the beneficiary turns 18. The trust can continue. However, the trustees will need to notify the beneficiary and pass on details of income and gains generated so that the beneficiary can declare them on their tax return.

If a beneficiary demands the trust property once they are 18, the trustees must pay it to them. In Scotland the age of demand is 16.

Discretionary trusts allow the greatest level of flexibility. The trustees have discretion over the payment of both capital and income. This allows the trustees to pay out at the appropriate time if funds are needed for a particular purpose. They can wait until they feel that the beneficiaries are old enough to look after the money themselves.

The beneficiaries are usually described by class such as children or grandchildren. This means that if future children or grandchildren are born after the trust was created, they can benefit.

This flexibility comes at a price – tax. From an inheritance tax perspective, gifts into a discretionary trust may create a chargeable lifetime transfer. Settlements over the nil rate band (£325,000) they will incur a 20% tax charge. There could also be periodic and exit charges depending upon the value of the trust. 

The trustees pay tax at 45% on any income (39.35% for dividends). Capital gains are assessed on the trust at 20% (28% on property) with up to half the personal annual CGT exemption available.

The parental settlement rules apply where the child is absolutely entitled to income, so if the parent creates a discretionary trust, the child has no right to income so the parental settlement rule will only apply if income is actually paid to or for the benefit of the child.

Whether you opt for a Bare trust to shelter money for a specific beneficiary or a Discretionary trust for a wider selection of beneficiaries, you do have a wide range of investment options available. The money can be held in cash savings, National Savings, and longer-term investment funds. To make use of allowances, exemptions or to mitigate the tax on the trust fund, you can use various tax wrappers to optimise your trust. The two most popular, Personal Portfolios and Investment Bonds, are found in your Wrap account.

There is no denying that trusts are more costly, both in terms of fees and your time. There is more administration and responsibility. Registering the trust, setting up bank accounts, filing a tax return, attending trustee meetings, reviewing investments, appointing or removing trustees, and appointing capital and income to the beneficiaries. 

And finally, pensions.

If you really want to ensure your gift was held for the very long term and not accessible until later life, you can make third party pension contributions into a child or grandchild’s pension. That’s right, there is no minimum age to set up a pension. It must be set up by the parent or guardian but once set up, anyone can pay in. The downside is that the child cannot access the money until their minimum pension age, currently age 55 but moving to age 58.

If the child has no earnings, then contributions will be limited to £2,880 a year but grossed up to £3,600 with the addition of basic rate tax relief. Higher contributions can be made if the child has earned income. Contribution limits are based upon the child’s tax position.Paying contributions to an adult child’s pension can free up their own income to be used on other things, a deposit for their first home, mortgage payments, childcare or education etc. It seems you are never too old or too young to fund a pension!

Summary

I would recommend you seek advice from your Financial Planner on what option, or combination of options will best meet your objectives. We have seen firsthand the joy a gift can bring and how it has a positive impact on your children and grandchildren. It makes them curious about how investments work and learning that lesson early on in life is such an advantage. 

PS. Don’t be too afraid of them having access at age 18. You may have been a bit hedonistic back in the day, it doesn’t mean they will be! But let’s keep that between ourselves! 😉

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2 thoughts on “Gifting money to children and grandchildren”

  1. Avatar

    As always – very interesting! Gladders have crossed that bridge though. So many options!
    I like the advice to have faith in your (grand)children’s actions once they turn 18/21. I’m sure you are right. Sensible parents educate their offspring into sensible children!

    1. Graham

      Thanks Saskia. It is important to start the money conversation with your children as soon as is reasonable. Don’t leave it too late. Getting them to save a small part of any pocket money from an early age would set a good example.

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