Make saving child’s play

For many years investing for children has been bedevilled by the parent-child settlement rules. It is easy, in principle, to avoid tax by making gifts of income producing assets to children, either directly or through the medium of a trust.

This tax reduction strategy, sometimes called ‘income splitting’, was regarded as unacceptable and anti-avoidance legislation was introduced. This legislation affects ‘parental trusts’ for minors.

A parental trust for minors is one where a ‘relevant child’ – a child aged under 18 who has never been married or in a civil partnership – of the settlor can benefit from a trust.

Parental trusts for minors can be:

• Bare (absolute) trusts.

• Interest in possession trusts, where the child is entitled to the trust income.

• Discretionary trusts.

The anti-avoidance provisions also cover more common situations, where there is no formal trust – situations where there is a gift from parent to child.

Where a child’s total income from gifts made by one parent exceeds £100 in any tax year, that income is treated as income of the parent. It should be noted that all of the income is treated as the parent’s income and not simply the excess above £100.

For example, John makes regular gifts of cash to his two daughters, Anna aged 13 and Belle aged 15, who deposit the money in building society accounts in their own names. In 2011/2012 the income arising to Anna was £50 and to Belle, £105. As Anna’s £50 income is below the £100 threshold it is not treated as John’s income. However all of Belle’s income is treated as that of her father.

In another example, Peter makes regular gifts of cash to his 14-year-old son Arthur who deposits the money in a bank account. Arthur’s mother, Mary, gives her son a holding of shares in an investment trust.

In 2011/2012 the bank interest was £80 and the dividends received from the investment trust were £120. The bank interest is less than £100 so is not treated as Peter’s income. However as the dividends exceed £100, they are treated as Mary’s income.

If one parent had made all the gifts, the full £200 would be treated as that parent’s income.

These rules do not apply to trusts created by, and funded by, grandparents, or gifts from grandparents. However, in the current economic climate it is often difficult for grandparents to make significant gifts to grandchildren.

The parent-child settlement rules do not apply to Junior Isas. This offers them a considerable advantage over alternative investment strategies for children.

Junior Isas are opened and managed by a parent, but the account is in the child’s name. Once opened anyone can contribute. The annual contribution allowance is £3600. No withdrawals are allowed until the child reaches 18. At that point the Junior Isa becomes a ‘normal’ Isa, at which point the owner – the child who has grown up – has full access to the investment.