Is a junior ISA really the best way to save for your child?

Is a junior ISA really the best way to save for your child?

June 14, 2020

There’s something that I’ve always found a little bit hard to get comfortable with when thinking about saving for my children. I’m comfortable with the money being in her name, but locking it up till she’s 18 has stopped me from putting as much money as I would’ve into their JISAs (Junior ISAs)). What if there’s something that we want to use that money for earlier? School trips, private school fees, driving lessons/first car, music lessons? The list goes on.

These are all expensive things that happen before a kid turns 18, and they tend to be funded straight from the parent’s pockets’ — especially if all the money you’re saving for them has been locked into a JISA. This normally leaves 3 options:

  1. Pay for it with any spare money you have (which can cause huge stress on your life for some of the larger costs)
  2. Save it in a kids saving account so you can withdraw it whenever you want (but it seems silly to earn 1-2%ish on long-term savings)
  3. Invest in your own ISA (tends to be used for other things that benefit the parents and not the child)

I want to open your eyes to a fourth option that’s less well known, especially if you don’t have a financial adviser. A Bare Trust. 

What is a Bare Trust?

Very simply put, a Bare Trust is one where the beneficiary (your child in this case) has a right to all the money in the trust when they reach 18, but you can use it earlier — provided that the money is used for their benefit.

The main differences between a JISA and a Bare Trust are:

  1. Flexibility to withdraw the funds from the trust before your child reaches the age of 18 if the purpose is for the child’s benefit. 
  2. The money doesn’t automatically go to the child at 18 (but can they request it)
  3. It’s not tax-free, but the Bare Trust can utilise the child’s capital gains and income tax allowances. 

For this post, I’m going to focus on capital gains tax and the differences between a JISA (locked up till 18) and a Bare Trust (flexibility but potential tax implications).

Capital gains tax

Like us, children also have a capital gains tax (CGT) allowance each year. For this tax year (22/23) the allowance is £12.3k. To keep things simple I’m going to assume that it stays at that figure for the next 18 years, but keep in mind that this may change in the future.

So this means your child only ever has to pay tax if you sell the investments and makeover £12.3k profit in a single year. How likely this is to happen really depends on how much you save and invest for them each year and how much you withdraw in a given year. I’m going to run through some examples to show you that despite the investments being taxable, it really only comes into play for larger amounts (keep in mind that these are examples and how you’re taxed will depend on your individual circumstances and that could change in the future).

Example 1:

You invest £65 a month from the day your child is born and you get an average annual growth of 5% over the 18 years. In this example, your total balance would be around £22.5k by the time your child turns 18.

Your profit of £8.5k, however, would be below £12.3k annual CGT allowance, even if you withdrew all of the £22.5k money in one go just before the child’s 18th birthday.

The chart above is for illustrative purposes only and how you are taxed will depend on your circumstances. Assumes a hypothetical annual growth rate of 5%, but this isn’t guaranteed and your money can also go down when you invest. 

Example 2:

My second example looks at what would happen if you invested £250 each month and you got an average annual growth of 5% over the 18 years on that £250 invested each month. In this example, your total balance would be around £87k by the time your child turns 18.

In this example, you would only need to pay CGT if you sold all the assets at any point after the age of 12. So waiting until your child’s 18th birthday would result in a profit above the CGT allowance, as shown in the graph below and a tax bill.

The chart above shows that if you waited until 18 and withdrew the money, then you would pay tax on the profit over the CGT allowance – which is £21k in this example. 

For this reason, it would make the most sense to withdraw the money in chunks. The below graph shows how withdrawing  £10.5k a year from age 11–17 (e.g. to contribute towards school fees) and withdrawing the rest just after their 18 birthday can reduce the tax which needs to be paid. 

Information for illustrative purposes only and how you are taxed will depend on your circumstances. Assumes a hypothetical annual growth rate of 5%, but this isn’t guaranteed and your money can also go down when you invest. 

Withdrawing the money in £10.5k chunks ensures the profit made in any given year is never higher than the CGT allowance. In the end, when the remaining £13.5k is withdrawn, there is no CGT as the £13.5k is less than the £36k paid for the shares.

As you can see, a bare trust can be a great option if you’re saving for a child. They offer similar benefits to a JISA (if structured properly), can be moved over to an adult ISA (with a bit of forward planning) and have the added flexibility that they can be withdrawn from to help cover some costs that benefit your child. Despite all this, they still remain unknown to most parents and under-utilised. We want to change that.

At Nosso, we’re working hard to bring Bare Trusts to our platform, and make them accessible to all. We want to simplify the process as much as possible so you don’t need to go to a financial adviser or solicitor to create one for your children or Grandchildren.

‍If you want to find out more about creating a Bare Trust with Nosso you can do so here.

Disclaimer:

Don’t forget, when you invest your money is at risk. You might end up with more than you put in - or you might end up with less. This blog isn’t our advice, so please don’t change your plans or buy or sell any of your investments based on it. We don’t know your money situation, your plans for the future or how much experience you’ve got. If you’re unsure you should speak to a professional financial advisor.

Please note that how you are taxed depends on your individual circumstances and may be subject to changes in the future. If unsure, speak to a qualified tax advisor.