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Do you really understand Tax Free Savings for Children?

We intentionally use the phrase "Tax Free" rather than the "Tax efficient" here to highlight a point. Many will say there is a range of tax free investments in the UK and cite products such as Junior ISAs that help to shield children's income from the taxman. Yes they do to some degree, but as we argued in a previous post we don't believe in many cases that the benefits are real or can't otherwise be achieved without a JISA wrapper.

Tax Free Savings for Children

Semantics aside, we are still only talking about the crumbs rather than the cake itself. What we want to talk about is encouraging parents to save for children using income that hasn't already been taxed. Like many savings products, the JISA uses income that has already been taxed. Typically parents will earn a salary, have PAYE income tax deducted by their employer and then from what is left, put some in the child's JISA.

The investment decision is about trying to stop the tax man further taxing any gains. In effect the JISA is allowing children to avoid the £100 income tax rule on interest on bank deposits (which we don't think are necessarily the best investment for children).


JISA - Not Exactly Tax Free

It is also important to understand that Junior ISAs are not exactly tax free. If you invest in shares or funds that own shares then a dividend tax of 10% is deducted before you receive your dividend cheque. For tax payers this can be offset in your tax return, but for non tax payers (such as Junior ISAs, CTFs, adult pension funds etc) there is no ability to claim this tax back. Therefore even in tax "efficient" vehicles you are still being taxed.


Increasing The Pot

What we are missing is a way to significantly increase the savings pot in the first place for things such as education. To a very small degree this type of savings already exists with childcare vouchers, but we would like to see this type of program expanded to cover all education (primary, secondary and tertiary).  It is interesting to observe that through our tax system we are happy to give a large tax relief (income tax relief, loss relief, capital gains tax exemptions) for investments by people with sufficient money to invest, but not for broader investments in our future - our children.


Aiding The Rich?

Lets be clear, our intention is not to create more avenues for the wealthy to bypass income and inheritance tax laws. The problem with creating tax breaks is that they tend to work best for those that can afford it, or more specifically can afford the army of lawyer and accountants to fight it. There is a difference between legally optimising your tax affairs within a set of rules and tax avoidance - if you are not happy with the rules, ask the government to change them.


What Are Their Little Tricks?

There are simple strategies one can pursue such as borrowing against investment properties or share portfolios. This generates a cash lump sum and allows you to claim a tax deduction on the increased interest expense. Of course you need to have the investment properties or shares with sufficient equity to be able to do this and you have a more debt to pay off at some stage.

The ability to withdraw 25% of your pension tax free at age 55 is another alternative, but relies on having sufficient funds in your pension fund (and being 55). Similarly grandparents can start making regular contributions towards a child's expenses and if structured the right way can reduce potential Inheritance Tax liabilities. Again this relies on grandparents being in a sufficiently healthy financial situation.

The list goes on to include offshore bonds, putting income producing assets in family companies etc. In the case of schools there are other opportunities - upfront prepayment of fees, splitting the benefit of the schools tax free status with investment portfolios and so forth. I think you're starting to get the gist that there are a number of opportunities, but they all require capital of some form.


What about tax breaks for everyone?

Unfortunately this list is rather short. Other than what we have mentioned the main one is childcare vouchers which allows you to purchase vouchers for childcare (not schooling) from pre tax money. Under the current system you can receive up to £55 per week for basic (20%) tax payers but less for higher tax payers. The payments are not dependant upon how many children you have but both partners can claim them if offered by their employer.

Note that this system is changing in 2015 whereby the Government will contribute 20% of childcare costs up to £10,000 (£8,000 by parents and £2,000 from the state).


To Be Continued. . . 

In the follow up to this post, we will look at what could be done to make the system better. Stay tuned!



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