With the potential costs of a university education spiralling, house prices still being relatively high and the cost of weddings increasing, it has never been more important to begin a programme of savings for children and grandchildren.
Added to this the effective demise of the Child Trust Fund has left a gaping hole in effective provision.
In part 1 of this 2-part series, let’s examine some of the tax-efficient opportunities that remain.
Facts and Analysis
The economic downturn has had an important indirect impact on the finances of the younger person, typically people in the age group 18 to 25. As mentioned above, the financial needs of this group of people embrace three main areas.
The Costs of Higher Education
Because of the economic downturn, it is likely that more and more students will be encouraged to stay in higher education and go on to university. But this decision will have considerable financial implications. For example, many who graduate from university will begin their working lives wondering how they will ever repay their debts to large bank overdrafts, credit and store-card debts and money owed to the Student Loans Company.
Also, if their parents are also suffering financially they are likely to be less able to help.
Moreover, this financial burden is likely to increase.
Last year, the then Labour government was reported as planning a cut in the budget for higher education with a possible increase in tuition fees above the current 3,290 cap. As we’ve seen with the recent Parliamentary debate and vote, tuition fees are set to rise to 6,000 – 9,000 pa.
Inevitably greater financial pressure will be placed on universities and students alike and it seems certain that the costs of funding a university education will rise in the future.
Assistance With House Purchase
Although interest rates are comparatively low, the impact of the credit crunch is that mortgages are more difficult to obtain. Lenders will typically now expect a bigger deposit and base lending on a lower multiple of annual income making it much more difficult for the first- time buyer.
Moreover, although house prices may have dropped recently, residential property is still relatively expensive for the first- time buyer. The combination of these factors can make it very difficult for a young person to take the first step on the property ladder.
Wedding Costs
The expectation arising from a wedding is now much greater with the parties looking for a bigger and better reception and honeymoon. Costs can easily exceed 10,000 which can be very difficult to pay without some advance planning.
Who pays?
So what can be done to help these youngsters? Where a parent has excess capital or income, he/she could make effective advance provision for a child. However, this is undoubtedly becoming increasingly difficult.
Given the recent economic climate more and more parents will be concerned to protect their own future financial position rather than give assistance to their children.
For those parents with insufficient income or capital and who may require help with funding the costs of a university education, it may be worth asking grandparents for assistance.
Frequently, grandparents will have capital available that they do not need and they may be prepared to invest on behalf of a grandchild who aspires to a university education or to get on the housing ladder.
This will particularly be the case if those grandparents have cash available, perhaps because they have benefited from the housing market by selling a private residence and downsizing and, in so doing, have realised cash that is now surplus to their anticipated future requirements.
Some may also be in receipt of a guaranteed pension from an occupational pension scheme.
So what can parents and grandparents do now to make children more financially secure in the future?
The answer here is to consider a programme of saving as soon as possible to provide those funds in a tax efficient way and in a structure which is acceptable to them.
Let’s look at some of the options that are available.
The Child Trust Fund
This is one investment that is no longer available. It is being phased out which means that from 1 August 2010, for most, the initial government payment will reduce from 250 to 50. From 1 January 2011, there will be no initial payment.
Given the phased withdrawal of new Child Trust Funds, parents will need to give consideration to other tax-efficient savings plans for children / grandchildren, such as:
ISAs
It will make sense to consider tax-efficient investments, in particular the individual savings account (ISA). Currently, 10,200 per annum can be invested in an ISA – up to 5,100 into a cash ISA, with the balance into a stocks and shares ISA.
The benefit of the ISA is complete tax freedom on capital gains and virtually complete tax freedom on income. This means that investments have scope to increase in value at a faster pace and therefore the earlier a programme of ISA saving is established the better.
Unfortunately, a child cannot generally establish an ISA (although a 16 year old can effect a cash ISA if the money for the investment comes from the parent the 100 income tax rule will apply). Further as an ISA cannot be put in trust, this will mean that it is the parent / grandparent who will need to make the investment in his / her own name with a view to using the proceeds of the ISA for the benefit of a child when encashment occurs.
Personal Pension Plan
Another investment that a parent or grandparent could make for a child would be a personal pension plan. Here, a gross amount of 3,600 could be paid by the grandparent to a personal pension plan in the grandchild’s name – even though he was a minor.
The grandparent would make the payment net of 20% income tax and so 2,880 would be paid each year. The pension provider would reclaim the tax deducted from HM Revenue and Customs.
The benefits of this arrangement are:
- Basic rate tax relief at source on the contribution
- Investments held in a highly tax efficient fund
- Whilst contributions are gifts, the normal expenditure out of income exemption and annual 3,000 exemption would normally be available
- Tax free cash of 25% of the fund from age 55 for the grandchild
The downside of this is no access to the grandchild until age 55.
So this won’t help with university costs, mortgage costs or the costs of a wedding – well at the very least it’s unlikely for the latter!
Children’s Bonus Bonds
This investment is available from National Savings and provides a return free of income tax and capital gains tax. The Bonds earn a guaranteed fixed rate of interest for five years, with a guaranteed bonus addition on the fifth anniversary. At the time of writing the current Issue 34 of the Bonds pays 2.5% per annum compound over the 5 year term.
This return is derived from compound interest at the rate of 1.85% per annum plus the bonus at the end of 5 years which is equal to 3.56% of the Bond purchase price.
The maximum investment per child per Issue is 3,000 and the minimum 25. At each 5-year anniversary the Bond can be encashed or left to run to the next 5-year anniversary at the interest rates prevailing at that time. The Bond must mature at age 21 when a final bonus is added.
Although the Bonds are owned by the child they are issued to the child’s parent(s) or guardian(s) regardless of who the purchaser is.
Early encashment is possible, with penalties. As the controller(s) of the Bond the parent(s) or guardian(s) can encash the Bond up to the child’s sixteenth birthday; thereafter encashment rights lie with the child who is then in control of the Bond.
Before investing a check must be made to ensure that the proposed investment plus any amount already invested in the particular Issue for a particular child does not exceed 3,000.
The Financial Tips Bottom Line
As can be seen, there are various options (and we’ve not covered them all yet) available to invest and save for children. Take the time now to analyse how many of these strategies might be appropriate for your own situation.
Part 2 will follow next time where we’ll look at the use of Trust arrangements.
Ray Prince is a fee based Certified Financial Planner with Rutherford Wilkinson ltd, and helps UK Resident Doctors and Dentists plan to achieve their financial objectives. Just visit http://www.medicaldentalfs.com where you can request your free retirement planning guide.
Rutherford Wilkinson ltd is authorised and regulated by the Financial Services Authority.
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