Planning Financially for your family part 2
Open a savings account but be quick as rates may have already peaked
Setting up a child’s savings account – one that encourages them to save their own money and benefit from the compounding effect of interest payments – is a key life lesson that will not only prove invaluable as they progress into adulthood but also boost their chances of having a financially secure future.
Savings rates have improved rapidly in recent weeks with some children’s accounts offering better rates than adult adults. But while rates are at their highest levels in over a decade, the returns are still deeply negative in real terms when you factor in sky-high inflation.
It means parents and grandparents should shop around for the best deal rather than just picking the lender they bank with – and move fast. While the Bank of England’s base rate is currently 3% and expected to rise further to peak at about 4.5% next year, that is significantly lower than the 6% or more expected in the wake of former Chancellor Kwasi Kwarteng’s mini Budget.
That means savings rates may have already peaked, so locking in the best rate now for a set period will certainly pay off particularly if inflation, currently at a 41-year high of 11.1% halves – as it is expected to do – by the end of next year.
Choosing the right savings account depends on factors such as the child’s age, the interest rate, the type of bank card they want and the minimum amount they can have in the account. While some accounts only pay interest on balances up to a certain amount, such as up to £1,000 or £3,000, others offer tiered interest rates with higher rates on lower balances or vice versa.
Remember to carefully assess how much you contribute to a child’s savings account to avoid triggering an unnecessary tax bill. If the child receives more than £100 in interest from money given to them by the parent, then the parent is liable for tax on the interest if it is above their own personal savings allowance. The £100 limit does not apply to gifts given by grandparents or other relatives.
Go big and save up to £9,000 in a Junior ISA
While savings accounts are ideal for teaching young children about money, particularly if they want to save towards a new toy or gadget, for bigger financial goals such as funding a gap year, university fees or a first car, that require larger sums, a Junior ISA (JISA) is a better option. These are tax-free accounts to enable investments or savings to be built up for a child.
While the IHT rules still apply on the amounts donated, up to £9,000 can be saved into a JISA every tax year – with all returns free from tax – allowing parents and grandparents to potentially club together and contribute without the restrictions on the interest that can be applied that come with a savings account.
A child cannot manage the money themselves until they turn 16 and cannot access it until they are 18 – a good restriction for those that want to safeguard the money. At 18, the JISA can be converted into an adult ISA, allowing the child to access a pot of investments or cash they can put towards a car, university costs, a house deposit or leave invested until the right time comes to access the funds.
While many parents choose cash savings for their children’s JISAs, this may not be the best use of a long-term allowance that cannot be accessed until a child is 18 as returns will be negative in real terms after inflation and the child is unlikely to need a JISA to save tax on interest.
Like adults, children have a tax-free personal allowance enabling them to earn £12,570 income a year and a personal savings allowance, which means even basic rate taxpayers can earn up to £1,000 of savings interest tax free as well.
If you are prepared to put money aside for a child for a medium to longer term period, such as five years or more, then a Junior ISA can be used for making investments in the financial markets, with money held over the long-term benefitting from a compounded return that has the potential to beat inflation.
A child receiving just £50 a month in an investment JISA that earned 5% per year over 18 years would have a pot at the end worth £17,333, from a total contribution of £10,800 – an investment gain of £6,533 without factoring in any charges.
The same amount put into cash with a 3% interest rate would result in a final pot of just £14,275 – a gain of just £3,475.
A reason for picking a JISA, is that your child can roll the entire amount accumulated in their JISA into an adult ISA tax-free when they turn 18 – whereas money transferred from a bare trust (more on these below) is restricted to the £20,000 ISA annual allowance.