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Good financial planning can mimic benefits of child trust funds

Canny planning of mainstream investments can mimic the soon to be extinct tax benefits of child trust funds.


The tax-free child trust fund is set to go but with good planning, tax-efficient or even tax-free returns for children can be achieved through mainstream investments.

In theory, the tax treatment of a child’s investments is relatively straightforward but real life practicalities can present problems. I am often asked whether the designation of a unit trust/Oeic account constitutes a bare trust. The heart of this question is usually about how investment returns from mutual funds are taxed.

Children are entitled to the same income tax allowance as everyone else, so can have income up to £6,475 without paying tax. They also have the same annual capital gains tax allowance, so any capital gains up to £10,100 are tax-free. These allowances can be used effectively with mutual funds to keep tax to a minimum or avoid it altogether.

However, one must be aware of the anti-avoidance provisions where a parent or step-parent has given money to their child. Where such gifts to an unmarried child under the age of 18 produce more than £100 gross income a year, the whole of the income from the gifts (not just the excess) is taxed as the parent’s income. Each parent has a £100 limit.

In practice, parents may be able to avoid tax liability by choosing low yield, growth-oriented funds. This special rule does not apply to gifts from other relatives or friends and there is no similar rule for CGT, so that the allowance is available regardless of the origin of the capital.

However, for children to be the taxable entities, they must be the beneficial owners. Gifts must have been genuine and the child must own the money.

However, investments can often not be held directly by a child and an adult will invest in their own name but with beneficial ownership of the child. The law may seem clear on this but family affairs are so interconnected that arrange-ments can be open to question unless properly documented.

It might be questioned if there has been a genuine gift as opposed to the relative merely putting money aside that they may or may not give to a child later. Until the gift is complete, the child will not be the beneficial owner and it will be the relative that is taxed.

This can be quite profound for CGT. If you invest yourself and then later transfer the investment to the child, it will be a chargeable transfer at that time and you will have to pay any tax due (irrespective that the investment has not been cashed in), with the child acquiring the assets at the market value. The child’s CGT allowance will relate only to growth achieved while the child has the money.

To assert that the child’s tax allowances and rates should be used, we need to show it is the child’s money. Whether the child is the beneficial owner is a matter of fact and while such facts need not be evidenced in writing, it is helpful if they are. The act of designating an investment account, in itself, is unlikely to be conclusive of ownership.

A simple express bare trust can be effective in putting any question of ownership beyond doubt. A formal document will outline what the gift is and will clarify that the adult investor is holding the investment on behalf of the child and beneficial owner.

A formal deed of gift is another alternative. Of course, an express trust arrangement will not always be possible if, for example, the child has inherited assets. Here, however, we will have tangible external facts to show the nature of the arrangement.

Parents may well wonder if it is a good idea to adopt an approach of constructive ambiguity in the hope that the child is taxed but with the possibility of the assets being reclaimed in future if required. This is not achievable because, in law and for tax, it is either the child’s money or it is not.

Paul Kennedy is director of tax planning at Fidelity


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