Helping your child save and invest can be a practical way for them to build a substantial nest egg to secure their financial future and afford any milestone purchases when they reach critical stages of life.
While this is all well and good, it’s essential to understand the tax rules regarding your children’s savings. Despite the importance of this, MoneyWeek reveals that a fifth of parents still aren’t sure how their children’s savings are taxed.
If you don’t understand the tax rules on your children’s savings, you may face a considerable and unexpected bill.
Continue reading to discover how your children’s nest egg could be taxed, and some tax-efficient saving vessels you could use to save for their future.
Children have several tax-free allowances to make the most of
While it is somewhat unlikely that your children’s savings will be taxed, there are still occasions when it can happen.
Like adults, children also have access to several tax-free allowances that allow them to grow their wealth without incurring tax liability.
First, they can benefit from an Income Tax Personal Allowance, allowing them to generate a certain amount of income – including savings interest – before they start paying tax. As of the 2023/24 financial year, this stands at £12,570.
Moreover, they can also make the most of the Personal Savings Allowance (PSA), allowing them to earn an additional £1,000 in interest on savings tax-free in 2023/24 if they pay no Income Tax, or do so at the basic rate.
This essentially means that, when combined with the Income Tax Personal Allowance, your children can potentially earn up to £13,570 in interest on their savings tax-free.
Better yet, the starting rate for savings, which is designed to encourage savings among lower earners, boosts their tax-free allowance.
Indeed, the incentive means that if your children’s income is equal to or less than the Personal Allowance, they can earn an extra £5,000 in tax-free interest.
You should keep in mind that for each £1 your children earn over the Personal Allowance, the starting rate for savings reduces by £1.
Overall, though, the combination of the Personal Allowance, PSA, and the full amount of starting rate for savings pushes the amount your child can earn tax-efficiently to up to £18,570.
You could be liable for tax if you gift money to your children
As you can see, since your children receive a relatively high tax-free allowance, and the fact that they likely aren’t earning large sums of money yet, it’s somewhat unlikely that they will pay tax on their savings interest.
However, it’s essential to note that if you’ve gifted wealth to your children, it may be immediately treated as part of your own PSA, not your children’s.
In fact, as soon as your child starts earning at least £100 in savings interest on money you’ve gifted them – or £200 if both parents give money – it could form part of your PSA. In 2023/24, this threshold is:
- £1,000 for basic-rate taxpayers
- £500 for higher-rate taxpayers
- £0 for additional-rate taxpayers.
So, if you gift wealth to your children and are unaware of the tax rules on savings interest, you may be pushed over your PSA, and may need to pay more Income Tax than you initially expected.
Thankfully, there is a way you could tax-efficiently save for your children – read on to find out how to do so.
Junior ISAs could help you save for your children tax-efficiently
Even though your children may be unlikely to pay tax on their savings interest, it may still be worth helping them save for their future through a tax-efficient account. This could be especially important if you regularly gift your children money since this could affect your own PSA.
One of the ways you could help your child tax-efficiently save is with a Junior ISA (JISA).
These replaced Child Trust Funds in 2011, and you could open either a Cash JISA, which allows your children to save money and earn interest much like a traditional savings account, or a Stocks and Shares JISA, enabling you to invest in a range of securities in your child’s name and generate returns.
Perhaps the most significant benefit of JISAs is that, much like their adult counterparts, wealth within is sheltered from tax.
Indeed, interest and returns are free from Capital Gains Tax and Income Tax, while dividends earned through the Stocks and Shares JISA aren’t liable for Dividend Tax.
You can save and invest for your child through a JISA, and when they reach the age of 18, they can then access the wealth held within to use for any milestone purchases, such as university fees or their first home.
It’s worth noting that JISAs have a separate allowance from your own ISA allowance, which stands at £9,000 in 2023/24. This is in your child’s name, meaning you can still make the most of your own £20,000 allowance alongside your child’s.
Additionally, since any cash gifts your child receives from their grandparents or friends typically aren’t assessed against your own PSA, it may be worth encouraging monetary gifts for your children’s birthdays or Christmas.
Investments carry risk. The value of your investments (and any income from them) can go down as well as up and you may not get back the full amount you invested.
Get in touch
If you’re still unsure what the best way to save for your children tax-efficiently would be, then we can help.
Please contact us by email at info@investmentsense.co.uk or call 0115 933 8433 to find out more.
Please note
This article is for general information only and does not constitute advice. The information is aimed at retail clients only. Please do not act based on anything you might read in this article. All contents are based on our understanding of HMRC legislation, which is subject to change.
Levels, bases of and reliefs from taxation may be subject to change and their value depends on the individual circumstances of the investor. The Financial Conduct Authority does not regulate Tax advice.
