‘What if Christmas, he thought, doesn’t come from a store. What if Christmas, perhaps, means a little bit more” – Dr Seuss’ The Grinch.
If you’ve had enough of Lego and LOL dolls before they’re even under the tree, you could consider giving a gift that lasts this Christmas. We’re not saying ditch the flashy, fun-to-open gifts all together, but you might want to throw in a little money among them. This doesn’t mean a wad of cash in a card, but money (even a small amount) that will grow alongside your child.
With so many financial blows hitting budgets lately – the pandemic and the cost-of-living crisis for starters – a financial gift can help to protect young family members from similar shocks in the future.
But before you dip your hand in your pocket, the tax efficiency of a money gift requires careful thought. Here are five tax-friendly financial gift options this Christmas, from the experts at DIY investment platform Bestinvest:
1. Open a savings account but be quick as rates may have already peaked
For those unsure about the tax implications of a financial gift and whether they can afford it, setting up a child’s savings account that pays interest is a good start. This will help them to understand the value of saving and earning, and making their money work hard for them.
Savings rates have jumped up over the past year with some children’s accounts offering better deals than adult accounts, such as up to five per cent on an easy-access account or two-year fix and up to 5.8 per cent on a regular saver. Rates are significantly better than they were a year ago, but expectations are mounting that the base rate has already peaked, meaning the best deals could disappear soon. So move fast!
Top tax tip: Track how much you contribute to a child’s savings account. 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.
2. Save up to £9,000 in a ‘tax-free’ Junior ISA and turn your child into an ISA millionaire by the age of 44
For bigger, long-term financial goals such as funding a gap year, university fees, or a first car or deposit on a home, opening a Junior ISA (JISA) for a child may be a better option. These tax wrappers enable a child’s cash or investments to grow free of tax on income or capital growth and don’t run the risk of a parent breaching the Personal Savings Allowance on interest earned in a bank or building society account.
While inheritance tax (IHT) rules can apply on the amounts donated (see more below), 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 come with a savings account.
At 18, the JISA can be converted into an adult ISA, where the annual allowance jumps to £20,000. From 18, the child can access the funds or leave it invested.
For those willing to put money aside for a child for a medium to longer term period, such as five years or more, then a Stocks & Shares JISA can be used to make investments in the financial markets.
See our top ethical JISAs
Top tax tip: Regular investing pays off. If a family invested £9,000 a year in a Junior ISA for 18-years, based on a five per cent annual compound growth rate, the child would accumulate £269,048. If that money was rolled into an adult ISA at 18 and no more contributions were made, by the age of 44 the balance would have topped £1 million.
3. Set your child up for a comfortable retirement by opening a pension now
Ok, a child might not thank you for this gift now, but they certainly will in later life. Non-taxpayers, including children, have an annual gross pension allowance of £3,600 with contributions attracting 20 per cent tax relief. This means a relative can invest up to £2,880 into a child’s Self-Invested Personal Pension (SIPP), which is then topped up by the Government with £720 in tax relief.
A sum of £2,880 invested every year in a child SIPP, topped up with government tax relief of £12,960, would mean total contributions of £64,800 over 18 years. Were those contributions to grow by an annual compound growth rate of five per cent, then at 18 the pension would be worth an impressive £107,619. Even if no further contributions were ever made after this age, the pension would tip over £1 million by the age of 62, just in time for retirement, with an annual compound return of 5 per cent.
See our top ethical pension funds
Top tax tip: If you could afford (and that’s a big IF) to max out the JISA and SIPP allowances, your child could reach that £1 million mark earlier. They could amass £376,668 by the age of 18. With no further contributions after that, the overall sum in both accounts could grow to more than £1 million by the time the child turned 37.
4. Cash is an easy gift and can reduce your inheritance tax bill
Cash gifts are always welcome and can be an effective way to reduce inheritance tax (IHT) liability. But if you don’t live more than seven years after making the gift, the beneficiary might have to pay it. Currently, there is a nil tax rate band of £325,000 and an additional £175,000 residence nil rate band where a main residence is left to direct descendants. Sums over this limit can potentially attract a 40 per cent tax-charge payable by your beneficiaries.
Top tax tip:
There are exemptions outside the seven-year rule that allow people to make financial gifts without saddling their beneficiaries with a big tax bill. These include:
- The £3,000 rule: Up to £3,000 can be given away every year tax-free. This allowance can be carried forward for one tax-year. For a couple, those figures double, with up to £6,000 per couple per tax year and up to £12,000 if the allowance is carried forward for a year.
- The small gift allowance rule: Multiple cash sums of up to £250 per recipient can be given tax-free.
- The gifts from surplus income rule: People can give away as much money as they want, as long it comes out of their regular income – such as employment or pension income rather than capital – and does not diminish the giver’s standard of living in any way. In other words, it must be affordable after they have covered their normal outgoings.
- The wedding gift rule: Parents can give £5,000 to a child, while grandparents can gift £2,500 to a grandchild to help cover wedding expenses.
5. For adult children, a Lifetime ISA is a no brainer
The bank of mum and dad has gifted more than £35 billion to help their children and grandchildren get on the housing ladder over the past five years, according to a November study from SunLife, highlighting how hard it is for young people to save the sizeable sum needed for a deposit.
Contributing towards a Lifetime ISA (LISA), which is specifically designed for house deposit savings, can accelerate this process as it comes with generous tax benefits. Savers aged between 18 and 39 can contribute up to £4,000 a year into a LISA, and the government will top it up by 25%. That’s a ‘free cash’ bonus of up to £1,000 a year. After 39, an existing LISA account holder can continue to pay in and still receive the state top up until they are 50. The maximum bonus for someone who opened an account at 18 and maxed it out until they hit 50 is a very generous £33,000.
Like other ISAs, any income or capital growth within the LISA is shielded from income tax, capital gains tax and dividend tax. There are a few tricky rules, however: the pot must go towards either the purchase of your first property (capped at £450,000 in value) or be held until you are at least 60. Withdrawals before 60, other than for a first property purchase, will be subject to a 25 per cent penalty as the state top-ups are clawed back.
Top tax tip: If a child turns 18 and their parent has set aside funds for them in a JISA, they can divert £4,000 straight into a LISA, receiving an instant £1,000 boost on their journey towards home ownership. The remaining £16,000 from their £20,000 allowance can be diverted into a regular cash or investment ISA.