In my last article before the summer break, I looked at some recent research into the costs of providing for education and how many parents are just not financially prepared for it.
Many of those contributing to such costs stated that, with the benefit of hindsight, they wished they had started saving earlier.
I ended with the conclusion that the earlier you do start to save for these significant costs, the more likely you are to avoid the financial pain of “paying as you go”. Even more so if you can do it tax efficiently.
Before I look at some classic tax-effective savings strategies, I thought it would be worth a little review of the fundamentals in relation to investing for children.
There are special rules to consider when investments are made for the benefit, or on behalf, of minor children. Knowing them is essential to getting it right when establishing a tax-efficient investment strategy for clients.
First, it is important to ascertain whose money is being invested, as this will impact on investment choice. In most cases, the investor and provider of the funds is the child’s parent or grandparent. But sometimes it might not be quite so straightforward.
For example, cash may have been left to a child under a will. In these circumstances, there is likely to be a trust (whether expressed or implied by law) and the investment will need to be made by the trustee (i.e. the adult who has legal control over the cash).
Further questions may need to be asked to establish who owns the funds. For example, where cash has originated from a grandparent, it would be entirely possible the gift was made to the parent in the hope the cash would be used for the benefit of the grandchild but without conferring any legal obligation on the parent to that effect.
This is a simple but important point that needs to be ascertained so the correct tax and legal consequences can flow.
Remember that in England, Wales and Northern Ireland, a child attains majority at age 18 and, until then, their rights to make contracts are restricted (different rules apply in Scotland). This means a minor child cannot generally make an investment in their own name.
So even if, on the face of it, the funds belong to the child, any investment will usually need to be made by an adult as a donor, nominee or trustee (although special rules apply to bank accounts).
So how about taxation?
Subject to the special rules applicable when the sums invested for a minor originate from a parent, a child is treated in the same way as an adult for tax purposes. This means they are subject to income tax and capital gains tax with the benefit of a personal income tax allowance, a personal savings allowance, dividend allowance, a starting rate tax band and a CGT annual exemption.
However, where income is produced as a result of a settlement (which, broadly speaking, covers all gifts) made by a parent for their unmarried minor child who is not in a civil partnership, the income is assessed on the parental donor, unless the total gross income which comes from capital provided by that parent for the child does not exceed £100 in a tax year. This is known as the parental settlement rule.
While tax efficiency is not the be-all-and-end-all of financial planning, getting it right can be a huge contributor to achieving the investment objectives. Next week, I will have a look at some tax-efficient savings strategies for investing for children.
Tony Wickenden is joint managing director of Technical Connection.
You can find him Tweeting @tecconn