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www.InvestmentGuide.co.uk A child's income and tax allowance
This chapter is mainly concerned with infant children, that is children who are under the age of 18. For information about giving money to adult children, you need to read the Chapter Giving Money to Adult Children. Up to the age of 18 you can hold money in your own name (or in your husband's or wife's name or jointly) which legally belongs to your child. At age 18 the child can demand that the money is put in his or her own name unless the money is given under a formal trust which provides for the trustees (which can be you and your husband or wife) to hold on to it for longer.
The way in which a child's investment income is taxed does not depend on whose name the money is in. It can be in the child's own name, a parent's name or a grandparent's name for example. It depends on who gave the money in the first place, whether the income or interest from it is accumulated or spent, and the terms of any trust which the money is subject to.
A child has a personal tax allowance from the day he or she is born. This is the same as anyone else's and is £6,475 for the 2009-2010 tax year (click for current and previous years). In addition each child also has his or her own basic rate tax band of £37,400 in 2009-2010 (click for previous years). So each child with investment income of up to £6,475 a year can pay £2,590 less tax than an adult who pays 40% tax.
It's even better for the super rich. Each of their children with an investment income from most forms of investments of around £40,000 pays about £10,000 a year less tax than if the income was instead part of their higher rate tax paying parent.
Where a child's income is below his or her personal tax allowance, it's may be best to find an investment where income tax is not deducted, so as to avoid the trouble and delay of obtaining an income tax rebate. If the best account happens to be a UK bank and building society account, the account can be made into one which does not deduct tax by getting a copy of Inland Revenue leaflet IR110 A Guide for People with Savings which can be found at the HM Revenue & Customs Leaflets & Booklets Home Page for each account you want to have this done on. There is a form at the back of the leaflet for you or the child (over age 16) to complete. However some of the better investments for children don't have tax deducted for anyone, see below.
Should a child invest in an account where tax is deducted but he or she is not be liable for it, this tax can be reclaimed using a special Tax Repayment Claim Form R232 from the Inland Revenue. This form is sent to a tax office specialising in repayment claims, with the relevant tax deduction certificates or tax vouchers once the child's income for the year is known.
Investments for a child in his or her own name
For money held in a child's own name consider the following:
Income from money given by parents
The taxman prevents parents from making direct use of their own child's tax allowance through giving money to them, by counting as a parent's income, any income over £100 a year from money or investments given to their child (or to any type of trust for their child). So if you give your child £1,000 and he or she gets £40 interest on it, that £40 counts as the child's income and is effectively tax free. However if you give the child £3,000 and the interest is £120, this amount is added to your income and taxed at your rate (40% if you are a higher rate taxpayer). This counting of a child's income as his or her parent's carries on until the child reaches age 18 or gets married over age 16 if earlier.
If any money is withdrawn from the account before the child is 18 or marries, that amount is added to the income of the parent who gave the money and is taxable in the tax year in which the withdrawal is made. This type of arrangement is not very satisfactory except for smallish amounts as the child is entitled to demand the money at age 18.
However at age 18 this changes. So if you want to help out a student or son or daughter who is unemployed, you could put money in their name which will not be taxable. However once the capital sum exceeds £3,000 it affects State benefits and there is none for those with capital of £8,000 or more. Students are not generally eligible for state benefits. If you want to give more than, say, £5,000 to your child, you should consider setting up a formal trust so you can keep control of the money until age 25 or even longer - see Trusts at the end of this Chapter. Money in a Trust will not affect State benefits for a beneficiary but any payment of income or capital from it to the beneficiary is very likely to do so.
Investments suitable for gifts from parents who don't want to bother with a formal trust (or in addition or separate from one) but may want to spend some income on the child (e.g. school fees, holidays) are. Currently these all pay rather poor interest.
The maximum limit for National Savings certificates can be doubled as investment can be made once up to the maximum in each child's own name, and once again in one or both of the parent's name as trustees for each child. Depending on how you fill in the form, the child may or may not have to sign when you cash these in trust holdings. These holdings are in addition to any the parents may have of their own (or in trust for each other). As these investments are tax exempt they are especially suitable for higher rate taxpayers - though the fixed interest issues don't represent good value. Investments in a child's own name requires his or her signature for withdrawal from age 7.
Money held in a child's own name or by trustees absolutely for the child after 7 years falls outside inheritance tax. Using savings certificates which can be physically kept by the donor or trustee (and which the child can theoretically demand to cash in once they are 18) but will normally forget about or not know about in the case of a trust is an expedient way of giving money away without the risk trhat the money will be spent on a sports car or motor bike.
Where money comes from any source other than a parent, and including money left to a child by a parent who has died, a child is taxed completely separately from his or her parents. So gifts from relatives and grandparents and money from Saturday jobs and newsrounds etc. can all be invested and interest received tax free up to the full personal tax allowance.
For money from this source, which can be held in a parent's name as nominee or bare trustee, consider accounts where tax is not deducted as the Inland Revenue form IR110 does not provide for this situation:
If you want to invest longer term, consider the following:
Also consider investments listed below under the heading School fees.
Child Trust Fund
This is a new scheme for children born on or after 1 September 2002. All money invested cannot be touched until the child is 18 but all interest and capital gains are tax exempt. For more details click here.
School fees
Private education is extremely expensive and most people are unlikely to be able to pay for it out of their income. Specialists in this field recommend people to start investing when a child is born in order to spread the burden. But because the rise in school fee charges can exceed the return from most schemes, people have been disappointed.
The investments listed below are suitable for basic and higher rate taxpayers. Non-taxpayers and reduced rate taxpayers are unlikely to be able to afford to pay for private education from their investments.
Invest regularly for school fees with:
Lump sums for school fees:
Lump sums of more than a year's fees which you want to earmark for school fees can usually be paid in advance to the school; check that there is no penalty if the child later changes schools. The lump sum earns interest and when the fees come due, both the lump sum and interest are available to pay them.
Large lump sums intended as payment for school fees and donated by a wealthy grandparent would be best invested through an accumulation and maintenance trust consult a solicitor or a chartered accountant for advice on how to set one up, see also below.
Income from money inherited by a child, or received as a gift from anyone other than its parents is not taxable to the extent of the personal tax allowance; choose instead investments listed under the heading Income from other money.
There are three types of trust:
Unless a trust specifically states it can invest in anything (which they usually do) trustees no longer have limits on where they can invest as a result of the Trustee Act 2000. Anything that is authorised by the Financial Services Authority is likely to be OK.
Accumulation and maintenance trust
Confusingly an accumulation and maintenance trust is sometimes described as discretionary, because the trustees usually have discretion to decide whether the income from the trust is accumulated or spent for the benefit of the beneficiaries or actually paid to them if they are over age 18.
Since 22 March 2006, new accumulation and maintenance trusts and additions to existing trusts have been treated in the same way as discretionary trusts (see below) unless the assets go to the beneficiary absolutely at the age of 18 (or the Trust was amended to achieve this before 6 April 2008) or the Trust is for a disabled person in which case the age of 25 applies instead of 18 and the new rules don't apply.
For new accumulation trusts or additions to existing ones where gifts exceed the cumulative inheritance tax exemption limit of the donor, there will be a tax charge of 20% inheritance tax when funds are given to the Trust. All such trusts will have to pay a 6% charge of their capital value every 10 years on any value of the Trust in excesss of the then inheritance tax limit. In practice existing trusts whose value is below the inheritance tax limit will be unaffected by the new inheritance tax charge.
There has been a change to the original proposals regarding accumulation and maintenance trusts set up by a Will: on death such Trusts will avoid the 20% inheritance tax charge (although not the 40% on the estate if it is liable for it) and a child who inherits at the age of 25 will pay tax at a rate of 4.2% on the value of the capital of theTrust every 10 years and pro-rata at the age of 25. You may need legal advice on the consequences of this if your Will provides for a Trust for children to receive money at age 25.
With an accumulation and maintenance trust a settlor, e.g. a grandparent, gives a sum of money, say £100,000, to a trust for at least one named beneficiary. The trust deed should be drafted by a solicitor or chartered accountant with experience in drafting such deeds and might cost you £50 to £500. Once the trust is set up, provided the trust says so, anyone else can add money to it (as well as the original settlor) but this should not be a parent, see Trust income below.
The primary beneficiaries of such a trust are the people named in the trust deed. However they need not yet be born. The deed might specify 'my grandson Simon Jones and any other grandchildren'. While Simon is the only grandson he is entitled to 100% of the income of the trust; but if later four brothers and sisters and cousins arrive, he will only be entitled to a fifth of the trust. Alternatively the trust can be for specified people only. Usually such trusts are more specific and refer to named primary beneficiaries; a new trust can be set up for any further grandchildren who arrive.
With an accumulation and maintenance trust, the trustees have no discretion about who gets income and capital. The share of each beneficiary must be according to the original trust deed. The only discretion is whether to pay out income to a beneficiary. If it is paid out to one beneficiary and not to another, then records have to be kept, showing each beneficiary's share, so that a beneficiary whose share has been accumulated does not get less.
With a discretionary trust you don't need to specify who the beneficiaries are. They can be in rather general terms like 'any of the descendants of John and Jane Brown'. The trustees can choose to whom they pay income to, and when; they can decide whether and to whom to advance any capital; when the trust is finally closed down, they can decide to whom the money is given. The settlor can leave informal instructions to the trustees on how they should use their discretion (for instance they could be told not to pay any income to anyone who spends it on gambling or illegal drugs).
Discretionary trusts (and now new accumulation and maintenance trusts) have a few snags, however. There can be inheritance tax when money is given to the trust. It comes into effect once cumulative gifts within the previous seven years exceed the inheritance tax threshold (£325,000 for the 2009-2010 tax year). The rate is half the rate paid on death (currently 20% instead of 40%). Discretionary trusts also have to pay inheritance tax once every 10 years on the capital value of their assets if they are worth more than the inheritance tax threshold at the time. Currently that tax is about 6% of the capital value of the Trust at the time.
If a discretionary trust is set up below the inheritance tax threshold, there is no inheritance tax when it is set up, provided cumulative gifts within the previous seven years including the amount given to the Trust are in total less than the current inheritance tax limit. There is nothing to stop a husband setting one up for £312,000 and his wife setting up a separate trust with identical provisions for a further £312,000. Both would remain below their respective thresholds and no inheritance tax would be payable. However if after 10 years, the value of assets grew above the then inheritance tax threshold, there could be some inheritance tax in the future on the then capital value in excess over the then threshold.
Income from a discretionary trust or an accumulation and maintenance trust is currently taxed at 40% (it is proposed to raise it to 50% from 2010-2011). Income paid by a trustee to a beneficiary is paid with this tax deducted at 40% but the beneficiary (or a beneficiary's parents in the case of a child beneficiary) can reclaim all (or part) of the tax if he or she is not liable to pay the full amount deducted.
In the case of income received by trustees which comes from UK dividends, since 6 April 2004 the Trustees have to pay 32½% tax to the Inland Revenue on the grossed up amount of the dividend but can set against this the 10% tax credit which is deducted at source and is not reclaimable; (it is proposed to raise the tax rate to 42½% from 2010-2011). This applies where dividend income is accumulated within the trust.
Small trusts with an annual income of £1,000 a year or less since 6 April 2006 pay tax at a rate of 20% for savings income or 10% for dividends. The £1,000 a year applies to all Trusts together of one particular settlor.
Where the beneficiaries are non-taxpayers and income is distributed to them, dividend income from shares or equities, investment trusts and equity unit trusts must be paid after deduction of tax at 40% (not including the 10% tax credit) - and the extra tax has to be paid by the trustee. The beneficiary can then reclaim the full 40%. This makes it less attractive than income from fixed interest stocks or bank and building society deposits if income is to be distributed.
These rules now make a Trust fund which is intended to accumulate money at a date some time in the future less attractive as the income and capital gains will be taxed at the same rate as the donor. The only tax saving will be the avoidance of inheritance tax after 7 years.
But if the Trust is intended to generate an income for a non-tax paying child or young adult, then investment in fixed interest stocks or bank and building society deposits will give a higher income and the whole of the 40% tax deducted by the trust can be reclaimed by the beneficiary or on behalf of the beneficiary. So long as the child only has a moderate income from the Trust, then the rise in the trust rate of income has no affect.
Income paid to unmarried children under 18 from a trust set up by a parent usually counts as the parent's income so no tax rebate is due. It's not usually worth a parent setting up a such a trust. Such trusts are usually set up by grandparents.
The settlor, the person who gave the money to set up the trust, must not benefit from it; otherwise there are no tax advantages.
The tax repayment claim when the income counts as the child's is made by the parent on the child's behalf using Tax Claim Form R232. The trustees must fill in Form R185E giving details of the amount of trust income paid to the parents or spent as well as the tax deducted and give the form to the parent who sends it in with the claim.
If parents are trustees, trust income must be spent on education (e.g. school fees), maintenance (e.g. clothes, food) or benefit (e.g. holidays, presents) to count as having been distributed by the trust and to enable the parent to claim a tax rebate. If the income of the trust is not spent, the 40% tax cannot he reclaimed. But if in a future year the income is spent (in addition to income in that year) the tax can be reclaimed then provided the child (or children) has enough tax allowances in that year.
The Inland Revenue sometime considers capital as well as income payments from discretionary trusts and fromaccumulation and maintenance trusts as the income of the beneficiary. Any payments are deemed to be after deduction of 40% tax. This doesn't apply when the trust is wound up, nor to payments of school fees out of capital which normally don't count as income although there may now be an inheritance tax charge of up to 6% when capital is taken out of an accumulation and maintenance trust as there already can be for a discretionary trust.
How to register trust holdings of National Savings Certificates
You can hold National Savings Certificates in trust for a spouse or child enabling you to raise the maximum you can invest. The following is an extract from a leaflet published by National Savings describing this facility.
A holding of Savings Certificates must be clearly noted in the
registration if it is a trust holding. Savings certificates bought by trustees
can be registered in one of two ways:
1. In trust for one or more named
beneficiaries and held in the names of the trustee(s) and beneficiaries
jointly. For example 'Mr J Smith and Mrs J Smith in trust for Miss W Smith.' In
this example Mr and Mrs Smith are the trustees and Miss W Smith is the
beneficiary. The names and signatures of all trustees and beneficiaries are
needed for registration. They must also sign for repayment or transfer.
2.
In the names of the trustees alone, provided the Certificates are noted as
representing trust funds. For example, 'Mr J Smith and Mrs J Smith Trustees'.
The title of the trust, e.g. 'Mary Smith Marriage Settlement should if possible
be given when the Certificates are bought. The signatures of all trustees are
needed and for any application for repayment or transfer.
More information about trusts
The Inland Revenue publishes a
free booklet IR 152 Trusts An Introduction from the
HM Revenue
& Customs Leaflets & Booklets Home Page. For more information about
trusts in the UK and overseas, see the Trusts and
Trustees web site.
 Last updated 26 April 2009 |
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