Parents with a young child face a dilemma: When is the right time to start saving for an educational fund or a savings scheme for their child?
Most parents want to provide a financial sum for their children at some point in the future. But many are confused as to how best to go about this, while some will have little in the way of financial resources.
Whatever the financial situation of the parents, there are crucial factors to consider before you implement any savings plans.
Firstly, the best way to ensure your child’s welfare is not to establish a savings plan of any kind. Instead, you should ensure that you have made proper life insurance planning arrangements that provide for a very substantial sum to be paid out tax free in the event of your death or disability.
- Only when these arrangements are made should you consider making arrangements for savings.
- You may be persuaded to make regular monthly payments into some form of savings scheme for your children. Think twice before you do so, as often the charges on these plans are very high. In addition, if in the future you experience financial problems you may have to miss a payment which could subject you to penalties.
Consider potential financial consequences of a future failed relationship.
If you have low financial resources then, rather than be tempted into saving regular monthly amounts you cannot afford, ask yourself who do you know who has money and loves your children? The answer is normally your own parents.
Grandparents are often delighted to make a contribution to their grandchildren’s welfare, particularly if this involves no ongoing commitment.
So here are some suggestions:-
Allow the grandparents to establish a bare trust for your children, or to make a one off payment into a pension for them.
Making sure no-one else get’s their hands on your Grandchilden’s money
A bare trust is a very simple form of trust, and is often used to hold shares for children under the age of 18. The trust can be created with minimal paperwork and expense, and can offer tax advantages.
While this can be a very simple and cost-effective way of passing shares to a child, it does have disadvantages. In particular, the child has the right to take possession of the shares at the age of 18 and deal with them as he or she sees fit.
If they put assets into a bare trust for their grandchildren, the income and capital gains are taxed as the beneficiary’s income and gains. This can be very advantageous. For example, a child’s income may be less than the annual personal allowance, and so tax-free. Similarly, any capital gains taken in a particular year might be less than the annual capital gains tax allowance – also tax-free.
Pension savings for Grandchildren
It is not widely known, but anyone can contribute to a pension scheme (without proof of earnings) so long as they contribute a maximum of £3,600 gross per annum.
What that means is that a net payment of £2880 can be paid into a pension account (yes, even for children) and the government will top this up to £3600. This can be a one off payment or it can be continued for as long as this tax perk is available.
This means that the government will top up the grandparents contributions of £2880 by adding a further £720.
You may be thinking why put monies into a pension for young children, when they have their whole lives to save? Pensions accumulate gross and saving a small sum at an early age can roll up into a considerable sum by age 55.
As I have said, the payment of £2880 can be a one off, or you can make repeat payments if you can afford to do so. Even making just three payments of £2880 (from the age of one) can accumulate to a sum of around £175,000 to £250,000 by age 55.
Parents saving for children
How much do the parents have available?
If only small capital amounts are possible then the parents should consider either a Junior ISA or making a pension contribution for their child.
A Junior ISA is a tax efficient way to save for your children’s future. The money you accumulate can be used to pay their university fees, a car, a wedding or simply to give them a head start in life.
Tax-efficient – Investment growth is free of income or capital gains tax
Works like a normal ISA – There is an annual limit and you can invest in stocks & shares or cash
Long term saving – Your child can access the savings when they reach 18 years of age
If the parents are wealthy they might consider placing a reasonable level of funds into a discretionary trust, particularly if this is wrapped around an offshore bond. This type of arrangement defers tax and can be exceptionally tax efficient if arranged properly. Take care with the trust wording and ensure it is flexible. The amount placed into the trust or “settled” would also be useful in potentially in making Inheritance Tax Savings as it would be a “potentially exempt transfer”. I intend to cover this more fully in another blog post.
Ray Best can help you protect your financial future. To find out more, simply click here!