I have a certain dislike of too-clever-by-half acronyms, such as BOGOF for Buy One Get One Free, or FOMO (Fear Of Missing Out), and I read a new one recently – BOMAD. If, like me, you’re a little behind the times, or don’t have children, you might not know that BOMAD is the Bank of Mum and Dad.
This all came to mind when I read that the Nationwide is launching a 10% deposit mortgage to help first-time buyers but is refusing applicants who have relied on BOMAD to provide more than one-quarter of the deposit. Apparently, the thinking is that having to find 75% of the deposit yourself indicates ‘that someone is able to save and manage their finances’.
So, if Mum and Dad are going to be limited in helping with the mortgage, what else can they do to help? Perhaps the answer is to start early, anticipating a property purchase many years into the future, or even a way-off retirement! What are the options for saving for your children? Just how rich can you make them?
Junior ISAs – tax free but hard to control
There are many ways that investments for children can be set up, and one of the first to come to mind is the Junior ISA (JISA). In the last Budget, the Chancellor increased the Junior ISA savings limit from £4,368 to a very much more substantial £9,000 per year.
If you start now with a £9,000 annual contribution, by age 18, a total of £162,000 will have been saved. And if each annual contribution achieves, say 5% growth per year, we are looking at a potential house deposit of a little over £253,000, tax free. That’s quite a substantial deposit, enough even to buy a modest flat outright.
But, the big drawback of the Junior ISA is that it automatically converts to an Adult ISA on the child’s eighteenth birthday, and the parents instantly lose any control over the cash. In other words, whether you think your son or daughter are capable of sensibly managing large sums at the age of 18 is totally irrelevant. The money will be theirs, to do with as they please, and there is nothing you can do about it.
So, what are the alternatives? Well, the attraction of the JISA is that it is tax-free. But every basic rate taxpayer (including a child) has a personal savings allowance of £1,000, and of course every child also has the standard personal Income Tax allowance, £12,500 in the 2020/21 tax year.
That is a lot of interest that could be earned before the tax dragon raises its head. So, you could open a bank account for a child and still pay no tax – although be aware that a parent (but not a grandparent – BOGAG?) would be liable to tax where interest is £100 or more in a year. And you still have the ‘age 18’ issue.
Interest rates are poor at the moment (actually, they are utterly terrible). With the potential that they could remain low for the very long-term there is a good argument for looking at equity-based investments.
How equity-based investments and trusts could help
Equities are not tax-free – they can pay taxable dividends – but the dividend allowance of £2,000 a year would cover a 4% dividend on a £50,000 investment (but again, the £100 income limit applies if the investment is gifted by a parent).
There will also be Capital Gains Tax on any realised profits, but that is also covered by a tax allowance, the Capital Gains Tax Exempt Amount (to give it its correct name) which, in the 2020/21 tax year, would allow for £12,300 of profits to be taken without any tax.
No child can hold an equity investment directly in their own name, but an adult can hold one in a designated account; you open an investment in your name but with the child’s name appended as a designation.
This has the effect of creating a bare trust, where you are the trustee and the child is the beneficiary. This is a rather informal arrangement, and it is preferable to create a formal bare trust since, to be effective, the gift must be irrevocable. Without a trust deed it is possible HMRC could argue the gift is not a true gift.
But, as with the JISA or a bank account, the beneficiary of a bare trust can ask to take control at age 18, so the same problem of access arises…but only if the child knows the trust exists, and you are under no obligation to say so (unless of course they earn enough to have an Income Tax liability).
Don’t forget the benefits of Premium Bonds
We shouldn’t forget Premium Bonds, from National Savings and Investments, which can be bought for children.
A Premium Bond is a £1 entry into a monthly draw to win a cash prize, ranging from £25 to £1 million. Naturally there are many more of the former than the latter; something like 3.3 million £25 prizes to two of the jackpots each month.
Of course, there’s no guarantee of any prize and many months can go by with nothing, but the more bonds you hold (50,000 is the maximum) the greater the chance of winning. And there is the tantalising (if remote) possibility of creating an instant millionaire toddler.
Consider a ‘future retirement’
So, what of that ‘future retirement’ I mentioned above? Well, it is possible to open a pension plan for a child and invest from as little as £10 per month to £2,880 per year and receive tax relief on the contributions.
Every £2,880 paid into the pension becomes £3,600 after tax relief is given, that’s a 25% uplift from day one. Once the child starts earning, they can take over funding the pension, but if you wish you can continue to fund it into their adulthood.
As you may know, a personal pension cannot be accessed until age 55, at the moment. But as the State Pension age increases, so will this minimum age. It is expected to be 58 by 2046 and will increase as life expectancy increases; a child born today could well have to wait until age 60, or beyond, before they can access a pension.
Sixty years is a very long investment term. Looking back at that JISA contribution that might buy a flat at age 18, where would a £3,600 a year pension be at age 60? Well your child might have become a millionaire (without having to rely on a Premium Bonds win).
£3,600 a year achieving 5% growth per year will be worth almost £1.3 million after 60 years. Now is that not a great way to instil a savings culture at the same time as helping to secure a future retirement?