05 April 2012
We all want to give our kids the best possible start in life. A practical way
to do this is to put some savings aside for them. You can save as much
money as you like but there are tax implications that you should be aware of.
Opening a savings account
Opening a savings account for your child is easy and there are lots of banks and building societies out there offering accounts that are specifically aimed at children. These accounts often offer slightly better rates than standard accounts too. In most cases a child can't have the account in their own name until the age of seven. Until this time a parent or guardian has to be the signatory. Different providers have different age limits and features so make sure that you check any limits and restrictions before opening an account.
There are also Government initiatives such as the Junior ISA and the Child Trust Fund, which fall in to the category of children's savings, but allow you to currently contribute up to £3,600 in the account year. A Junior ISA account year is in line with the tax year (6th April to 5th April) whereas the Child Trust Fund account year runs from the child's last birthday until the day before their next birthday.
Your child's tax free allowance
Basically, children have the same personal tax allowance as adults under the age of 65, £8,105 a year, for the tax year 2012-2013.
The difference is that most adults use up their tax allowance with the first £8,105 of their income. For children this obviously isn't usually the case, so as long as their “annual income” is less than this amount then they wouldn't pay tax on it.
For example: £145,000 in a savings account earning 5% per annum interest provides £7,250 income which is below the child’s tax threshold.
Tax on money given to children by their parents or relatives
Interest over £100 generated by a child's savings that comes from money given to them by each parent will be taxed at the parents' tax rate."
If a parent or step parent puts money into a child’s savings account the child can only earn up to £100 interest in a year on that money before they get taxed on it. This rule takes precedence over the one just mentioned as it specifically targets money given to children by their parents regardless of their overall income. Interest over £100 generated by a child's savings that comes from money given to them by each parent will be taxed at the parents' tax rate.
To follow the example above, £2,000 given to a child by a parent earning 5% per annum interest in a savings account generates the cut off amount of income (£100) allowed before tax would have to be paid at the parents' tax rate.
The good news is that this rule only applies to parents and step parents, not friends and other family members. So if the child's grandparents, uncles, aunties, gave them money and it was earning interest the £100 limit would not apply.
Making sure its tax free
To make sure that your child's savings (within the above limits) are automatically paid tax free contact HMRC for Form R85 (http://www.inlandrevenue.gov.uk/forms/r85.pdf). Complete this form and give it to the bank or building society that you've opened your child's account with. Once they have this they will exempt the interest on the savings from tax and you will avoid having to claim the tax back. Please note, this process is not necessary for the aforementioned tax efficient savings & investments vehicles.