Written by Barrie Dawson, technical manager at Prudential UK
This article is not intended to be financial advice to any individual. The views expressed are those of the author and Moneyfacts.co.uk does not endorse the content.
Looking for the potential of a better return than cash to build a savings pot for a minor child or grandchild to help with university fees or to give them a head start in early adulthood?
A popular product to achieve these goals is a stocks and shares Junior ISA (JISA). However, there are products adults can access via their financial adviser that can also be used to save for children. An offshore bond held in a discretionary trust is an alternative that is often recommended by financial advisers to achieve these goals, particularly for university fee planning.
There are two types of Junior ISA:
Contributions can be made by anyone but the account must be opened by a child’s parent or legal guardian. Contributions to a JISA are limited per child each tax year. The current tax year limit is £9,000 and this is the combined limit for both types of JISA e.g. if you contribute £9,000 to a stocks and shares JISA no contributions can be made to a Cash JISA for the same child that tax year.
Contributions to a JISA are effectively a gift to the child so you can’t get your money back. The JISA belongs to the child but they can’t withdraw it until age 18, except in exceptional circumstances (e.g. terminal illness).
The reason someone would consider a stocks and shares JISA is because it’s possible to achieve a higher return than cash but this is not guaranteed. When the child reaches age 18 the investment value could be less than contributions paid in.
There are two elements to this solution. The first is the investment vehicle which is the offshore bond and the second part is the discretionary trust. Firstly, let’s consider the offshore bond.
Offshore is a common term used to describe a range of locations where companies could offer customers growth on their funds that's largely free from tax. This includes "true offshore" locations such as the Channel Islands and the Isle of Man, and other locations such as Dublin. Tax treatment can vary from one type of investment to another, and from one market location to another.
Investment bonds are usually classed as a single premium ‘life insurance’ policy because a portion (often less than 1% of cash-in value) of the ‘life insurance’ policy can be paid out upon death. They are more of an investment product though as the premium you pay is invested on your behalf in investment funds of your choice with the aim of achieving capital growth.
Investment bonds mainly fall into two categories, onshore and offshore. In high-level terms offshore investment bonds are similar to UK investment bonds but there is one main difference. With an onshore bond, tax is payable on gains made (and investment income received) from the underlying investments of the life fund(s) invested in, whereas with an offshore bond no income or Capital Gains Tax is payable on the underlying investment. There may be an element of Withholding Tax that can't be recovered with certain funds. Withholding Tax is deducted from interest and dividends received by the fund(s).
The lack of tax on an offshore bond means that it could potentially grow faster than one that is onshore, although this isn't guaranteed. But, note that when you take withdrawals from the bond it may give rise to what’s called a chargeable event gain and these gains are subject to income tax. However, with careful planning by a financial adviser it’s possible to realise these gains without paying any tax. This is often the case for young adults who are non-taxpayers by making use of their available personal allowance, starting rate for savings and personal savings allowance.
The next part of the solution is the trust. There are three parties to a trust:
Life insurance companies generally offer two types of gift trust; an absolute trust and a discretionary trust. In high-level terms the difference between the two is that with an absolute gift trust you name the beneficiary and their share of the trust fund at outset. This cannot be changed at a later date and the beneficiary becomes entitled to their share at age 18 (or 16 in Scotland).
With a discretionary gift trust the trust deed will have a standard class (list) of “potential” beneficiaries, which are normally your children, grandchildren and remoter decedents. You also have the option to add or remove beneficiaries e.g. you could add a niece or nephew.
None of the beneficiaries are legally entitled to the trust fund. Ultimately it’s up to the trustee to decide who benefits from the trust fund and when. It’s this level of trustee discretion that makes the discretionary gift trust a popular option for those wishing to invest for minor children but want to retain an element of control over when the child gets the money. Furthermore, the ability to add or remove beneficiaries offers flexibility should you change your mind on who should benefit.
By transferring the offshore bond into a discretionary gift trust you are making an outright gift. You would be excluded from being a beneficiary so you can’t get your money back at a later date.
Which one of the above two options could be used to achieve your goals will depend on a number of factors and a financial adviser will be able to help you make a decision. But if you need to know a little bit more before approaching a financial adviser here are five key areas to consider.
If you are looking to pay monthly contributions of at least £25 but no more than £750 per child this could be achieved with a stocks & shares JISA.
Most offshore bonds are single premium contribution only with a minimum contribution of £20,000. There are some offshore bond providers with a monthly contribution option but minimum premium generally starts at £1,000.
If it’s a single premium contribution that you are looking to make then a JISA could be the option if the contribution per child will not exceed £9,000 (based on the current JISA allowance) in the tax year you make the contribution.
However, if you have £20,000 or more to invest per child or £20,000 or more for the benefit of several children then an offshore bond could be an option to discuss with your financial adviser.
With a stocks & shares JISA you need to set up an account per child and you would be restricted to one stocks & shares JISA provider per child. If you would like a separate policy per child then a stocks and shares ISA might be right for you. Although if you are not the child’s parent or legal guardian you’ll need to get their parent or legal guardian to open up the JISA account.
With an offshore bond the policy will be set up as a group of identical policies. For example, if you invest £20,000 the bond could be set up with 20 identical policies each initially worth £1,000. You could then earmark individual policies for each child that you want to benefit.
The offshore bond structure might be more appealing if there’s more than one child you want to invest for but don’t want to open several different accounts.
There are no restrictions on the amount of offshore bond providers that can be used (assuming minimum contribution levels can be met) which may be of interest if you are looking for product provider diversification.
Product diversification is an important consideration when it comes the Financial Services Compensation Scheme (FSCS). The FSCS protects your money if your product provider fails for any reason but you can only make one claim per FCA authorised institution.
For a Stocks & Shares JISA the FSCS will only cover £85,000 per person, per FCA authorised institution. The compensation limits are different for an offshore bond and you are protected up to 100% of the value of your claim, per FCA authorised institution.
If your total contributions over time are likely to be of significant value then FSCS protection and product diversification would be an important area to have a chat about with your financial adviser.
There are a wide range of investment choices available with the Stocks & Shares JISA and offshore bond options. If you are unsure about the different types of funds available and the associated risks this should steer you in the direction of your financial adviser.
Are you comfortable with the child getting access to the funds to do as they wish at age 18?
This is a very important question, particularly if contributions are likely to amount to a significant sum of money over time.
With a JISA the child can manage the funds from 16 and access the funds from age 18. You would not have control over the funds once the child reaches age 18. It’s not possible to gift a JISA into a discretionary trust.
If the savings are for a child with a disability who won’t have capacity to manage their financial affairs, it should be noted there’s currently no mechanism for their parent or legal guardian to automatically take control of a JISA.
The rules are slightly different depending on whether you live in Scotland, Northern Ireland, England or Wales but generally the parent or legal guardian will need to be appointed by the Court to manage the child’s affairs. For example, in England you would apply to become the child’s Deputy.
If you would like to control when the child gets the money then the option to gift the offshore bond into a discretionary gift trust could meet your goals. This would allow you and anyone you appoint as trustee to distribute funds to the child. Furthermore, you have the flexibility to change who can benefit. For example, this may be important if you’re initially investing for one child may want to split the contribution if you have more children (or grandchildren, nieces, nephews etc).
If you want to control when the child gets access to the funds then it would be worthwhile discussing the offshore bond and discretionary gift trust option with your financial adviser.
With the Stocks & Shares JISA there’s no tax payable during the investment journey and no tax payable when funds are withdrawn. So from an income and capital gains tax point of view the JISA is a simple and tax efficient solution.
In the unfortunate event of death of a minor child it should be noted that JISA funds are payable to the child’s personal representative. If they died intestate the funds would be shared equally between the parents (England, Wales & Northern Ireland). In Scotland the estate is split in two, half goes to the parents and half to the brothers or sisters. If you are the parent or legal guardian of the child and have inheritance tax problems this scenario should be carefully considered.
With the offshore bond route there’s generally no taxation during the investment journey but when taking withdrawals any chargeable gains created are chargeable to income tax. However, there are ways to ensure the gains are assessed against the child at their marginal rate and if this is done when they are a non-taxpayer then it’s possible that there will be no tax payable on withdrawals. In theory you can enjoy the same tax efficient journey as the JISA but this requires careful planning.
Discretionary gift trusts can be relatively straight forward but there are tax considerations in relation to investment gains on the offshore bond and potentially inheritance tax considerations as well.
Financial advice should be obtained to discuss any potential tax implications.
There’s no one size fits all solution!
The above information provides a high level overview of some of the key consideration but what product will best meet your objectives will depend on a number of different factors.
On the face of it investing for children sounds straight forward and this can be the case if you are looking a small regular contributions. However, if you are making large contributions and on an annual basis it can create more complexity and the solution to meet your goals may not be a product specifically designed for investing for children when taking other factors into account.
If you are in any doubt about what option is best for you an independent financial adviser will be best placed to help you make a decision.
Disclaimer: This information is intended solely to provide guidance and is not financial advice. Moneyfacts will not be liable for any loss arising from your use or reliance on this information. If you are in any doubt, Moneyfacts recommends you obtain independent financial advice.