10 Nov 2016
Author: Stephen Breen
Grandparents Judith and Michael Steel recently decided they wanted to save £100 a month for their two grandchildren – Bruno, aged 14, and Luc, aged 10. Their gifts were intended to reduce the value of their estate during their lifetime so that less inheritance tax would be paid on their death. However, the family soon discovered that opening a savings account for a child was not going to be straightforward.
Not one account – but six
The couple, who are both 76 and live in Edinburgh, asked their son to open accounts for his children, to receive the monthly gifts. The father shopped around and found Halifax had the best interest rate for a children’s savings account. He decided to open the Kids’ Regular Saver for each of his sons, which offers 4% interest for one year. However, the Halifax told him he must open another savings account first – because under the terms of the Kids’ Regular Saver, the savings had to be transferred automatically into another Halifax account at the end of the year.
The bank would also not allow this linked account to be a Halifax Junior Cash ISA account – so the father opened a Young Saver account for each of the boys instead. However, the father noticed that the Young Saver paid just 2% interest for up to £20,000 – while the Halifax Junior Cash ISA paid 3%. He therefore decided to open an additional Junior Cash ISA for each boy so that when the balance of the first account was transferred to the Young Saver at the end of the year, it could then be transferred on to the ISA.
So while Bruno and Luc needed just one account for the monthly gift their grandparents had offered, they ended up needing six. The father attended a 90 minute appointment at a Halifax branch in Edinburgh but was told that the bank’s computer system couldn’t deal with so many accounts being opened at once. The bank advised him to open each of the accounts online. However, the bank also warned the father that each time he opened an account, the online system would stop him opening another for three days. He would have to open the six accounts over a 18 day period.
Best buy child savings accounts
Although the family had a tough time completing what should have been a simple process, they did well to pick the accounts that they chose, which included:
- Kids’ Regular Saver – suitable for 0 – 15 years, 4% fixed interest for a year. Requires monthly deposit by standing order of £10 – £100.
- Halifax Junior Isa rate – 3% interest (annual limit: £4,080)
- Nationwide matches the 3% Halifax Junior ISA rate, and Coventry building society offers a slightly better rate of 3.25%.
- Savings accounts, ISAs and allowances
The interest paid on children’s savings accounts is tax free. Children will only pay tax if they have a personal income of £17,000 in a tax year. Money they receive from parents which generates interest over £100/year is also taxed as that parent’s income – this doesn’t apply to grandparents.
Junior ISAs come as either cash, or stocks and shares, ISAs. The cash ISA is simply a savings account, while the stocks and shares ISA holds investments such as funds and shares. The child’s annual ISA allowance (£4,080) can either be used for just one of the ISAs, or split across both.
While the parent has to initially open the ISA for the child, relatives and friends can then contribute to it. The child can withdraw the funds when they reach 18.
Since the tax treatment for children’s savings accounts and cash Junior ISAs is quite similar, it makes sense to use the savings accounts for cash savings and the £4,080 annual ISA allowance for stocks/shares. Investing in the stock market will typically outperform cash in the long term – for example, if parents had used the full annual Junior ISA allowance in a stocks and shares ISA invested in the FTSE All-Share index over the last five years, the pot would now be worth £22,895. By contrast, with cash savings the pot would only be worth £18,791 (source: Fidelity International).
Reducing your inheritance tax
The Steels were considering the future inheritance tax bill on their estate when making the gifts to their grandsons – although they admitted that this was rather late in the day. It is possible to make gifts to your grandchildren free from inheritance tax implications, provided that they do not affect your standard of living. HMRC advises that gifts can be made out of income for any amount, “amount as long as the person’s normal standard of living is not affected”. They note that donors must keep sufficient records of the gifts they have made and any other relevant information (for example, bank/building society statements), so their executors can use the records to claim for the inheritance tax exemption.
Grandparents can also gift £3,000 tax-free out of their savings each tax year, known as the annual exemption. Unused exemption can be carried forward for one year.
In addition they can give up to £2,500 for a wedding/civil ceremony gift, and they can contribute to a child’s on going living costs. They can also make as many gifts as they like to political parties and charities. On top of all these allowances, they can make unlimited small gifts (up to £250) tax free each year, provided that they have not already used another exemption on the recipient.
For all other gifts that do not fall into the above exemptions, inheritance tax will be due on the value of the gift unless you survive for 7 years after making it. The full rate is 40%, although this is tiered depending on how long you live after the gift was made.
Speak to our Later Life Planning team about reducing the inheritance tax on your estate through gifting.