”How to make your child a millionaire – through regular investing and using perfectly legitimate tax dodges’’ – the headline of a recent article in the Daily Mail.
Reading this article also makes it clear that we need to be well off to achieve this aim, and even more so, if we have more than one child. However, the article does usefully remind us of three basic ways by which we can deliver more modest nest eggs for our children or even grandchildren, tailored to our means, if we start early (as soon as they are born).
The three basic steps to take, which could see a child a millionaire by their 38th birthday, make the most of Junior ISAs, cash gifts and stakeholder pensions. Not only can we build a significant inheritance for a child, our actions will at the same time have cash benefits for us.
Step one: Junior ISA – your child is eligible for a Junior ISA if they were born after 1st January 2011 or if they were ineligible for a Child Trust Fund (CTF). Junior ISAs work in much the same way as a standard ISA with parents or legal guardians able to save up to £3,600 tax free in either a cash or investment ISA each tax year. The difference is that the money cannot be withdrawn until the child reaches 18 and it is the child who has access to the funds, not the parent.
If you were able to afford the full ISA annual allowance, year-on-year, paying 3 per cent (the average rate at the moment) would see £3,600 per year, which is £300 per month, become £85,782 by the time your child becomes 18. However, you could take more risk by choosing an investment ISA, where you could see returns of more like 6 per cent, making your payments hit a total £116,205.
Step two: Gifts into an investment fund or trust – another way to boost your children’s wealth and reduce your Inheritance tax (IHT) bill at the same time, is to make cash gifts. You have to survive for seven years after you give a cash gift for it to escape the IHT net. Unlimited gifts of up to £250 a person per tax year are tax exempt, as are payments of up to £5,000 for wedding gifts. The Revenue also allows you to ‘gift’ £3,000 every year to an individual.
But what is even better is that regular gifts, of any amount of money, once made from normal income, can be exempt from IHT. You must however show that you have been giving regularly and that your standard of living has not deteriorated as a result. HM Revenue & Customs will demand details of these gifts when the giver dies. Funds or investment trusts can be a good gift option, with currently an average growth of 5 per cent per year after charges and tax.
Step three: Pension Planning – here the major boost to the fund comes from setting up a pension for your child as soon as they are born. Often parents do not realise that they can do this, but by setting up a simple stakeholder pension plan you can start tackling your child’s pension from day one and help reduce your IHT bill at the same time. Even better, your contributions to a stakeholder pension plan are topped up by the government in tax relief, so your money will go even further.
If you put the maximum allowance into a stakeholder pension every month from the year your child is born (£3,660 p.a.), again assuming 6 per cent compound growth, the pot will grow to a value of £523,278 by age 38. However, it is important to remember that while the pension will play a major part in your child’s wealth by age 38, they won’t be able to access it under current rules until they are 55.
Saving £9,840 each year for the child to the age of 18 and £5,880 each year after discontinuing the Junior ISA element, would accumulate around £1.275 million – and all before your child reaches 40. However, as most of us realise, firstly we need to be earning a lot and secondly if we have more than one child, what we do for one we have to do for the others. Nevertheless doing what we can in all three areas would seem to be eminently sensible. The key as always is the sooner you start the better!