Parents often want to put money aside for their children. Grandparents and other relatives or friends might also choose to contribute to a little one’s financial future.
So, if this is you, where’s the best home for your cash? Junior ISAs are certainly worth considering. They came onto the market a couple of years ago and are proving popular with many savers. So what are they, and how do they work?
Who is eligible?
Junior ISAs are simply tax-efficient savings plan for children under the age of 18, but they are not available to everybody. You must be a 16 and UK resident to open a Junior ISA on behalf of a child, or be a child aged 16 or over but under 18 to open one on your own behalf (in which case only a stocks and shares Junior ISA can be opened).
Additionally, a child is not eligible for a Junior ISA if it qualified for a child trust fund (CTF). This rule basically excludes all children born between September 1, 2002, when CTFs were established, and January 3, 2011, when the government stopped all contributions to CTFs.
The government doesn’t make any contributions to the Junior ISA, but anyone else can chip in – parents, grandparents, relatives or friends
You cannot yet switch the money from a CTF into a Junior ISA, but the good news is that transfers will be allowed from April 2015.
Cash or shares
There are two types of Junior ISA. A cash Junior ISA is just like a savings account, except the interest is tax free. Or there are stocks and shares Junior ISAs that invest in the stock market. There is no additional income or capital gains tax to pay on any growth in a stocks and shares ISA (dividend income is subject to 10% tax at source).
Risk and reward
The choice of ISA depends largely on your attitude to risk and the age of your child. A stock market investment is more risky than a savings account and you could lose some or all your money if the market turned against you. However, shares typically outperform cash over the long term, so if your child is very young you might be prepared to take the bigger risk in the hope of bigger reward.
There are limits on the amount of money you can put into a Junior ISA. The annual allowance in the 2013/14 tax year is £3,720. In 2014/15 this rises to £3,840. (Child Trust Funds are subject to the same limits.)
Split the cash
The money can be split between the two types of Junior ISA, or you can put up to the maximum in just one if you prefer. For example, you might decide to deposit the full £3,720 in cash. Or, you might choose to save £2,000 in a cash account and £1,720 in shares. It’s entirely up to you, as long as you don’t exceed the total allowance in any one year.
The government doesn’t make any contributions to the Junior ISA, but anyone else can chip in – parents, grandparents, relatives or friends. The child cannot touch the money until he or she is 18, when the Junior ISA turns automatically into a standard ISA. The child can then take the cash or continue to save.
If the child is under 16 the parent or legal guardian - known as the registered contact - must open and manage the Junior ISA. However, it’s important to remember that the money belongs to the child and they can spend it how they wish when they reach 18.
Unlike with ‘adult’ ISAs, you cannot open a series of Junior ISAs year after year. But you can use each year’s annual allowance. So once you have taken your Junior ISA allowance (which can be allocated between the cash and stocks and shares versions), you must either put subsequent years’ allowance into the original account or, if you decide to open a new account, you must transfer all the money from previous years into this new one.
Switching Junior ISAs
You can only have one cash Junior ISA and one stocks and shares ISA at any particular time, but you can switch between the two. So, if you open a cash ISA at the start of the tax year, you can also open a stocks and shares ISA later in the year. You can then switch from cash to shares and vice versa.
You can also decide to switch your cash ISA or stocks and shares ISA to a different provider to get a better return. But you would have to transfer all the money so that you were left with only one cash and one stocks and shares Junior ISA. When you reach 16 you are eligible for a standard ISA, so you could in theory have both an ordinary ISA and a Junior ISA, giving you two bites at the tax-efficient cherry.
The rules are complex – and in some cases differ from the rules on standard ISAs (for example, you cannot switch from a standard stocks and shares ISA to a cash ISA). Bear in mind, though, that some firms do not accept transfers into their Junior ISAs. You might also have to pay a penalty if you want to switch money from a cash Junior ISA that pays a fixed rate for a set term.
The big attraction of Junior ISAs is their tax efficiency, but your child might not even pay tax. Everyone under the age of 65 can earn tax-free income – including savings interest – of up to £9,440 in the current tax year, so it is unlikely that your little one is liable for income tax unless they are a junior Rockefeller.
The £100 rule
You might therefore be better off shunning Junior ISAs in favour of an ordinary children savings account that pays a higher rate of interest. However, you have to watch out for the so-called £100 rule. This states that, if the money in the savings account is a gift from the parent and it generates more than £100 in interest a year, all the interest – not just the slice above £100 – is taxed as the parent’s own.
Pros and cons
Junior ISAs do not suit everybody. Some people want access to their savings before the child reaches 18 – and they want control over how the money is spent. The tax advantages of Junior ISAs are also irrelevant to some savers.
However, a Junior ISA might be a good option if you are in danger of breaching the £100 rule, or your child already earns close to the tax-free threshold. It’s also worth bearing in mind that the Junior ISA becomes a standard ISA when the child reaches 18, which means your offspring can continue to earn tax-free interest, even if they have started work and are liable for income tax.
Find the best deal
You can compare rates on Junior ISAs here at MoneySupermarket, to help you find the best product for your needs.