Children’s Savings Guide

Every parent wants to provide their kids with the best possible start in life. What kind of expectations does your child have? Our research has shown that teens expect to move out at 22, get their dream job at 25 and buy a home at 28.

Making wise financial decisions now can lead to a wonderful gift for the future.

Not only can savings help them pay for the important stuff – going to university, buying their first home, or even funding a gap year – but getting kids involved in saving is a good way to teach them about money.

What are the best children’s savings accounts?

Children’s savings accounts

Children’s savings accounts are savings accounts designed specifically for children. Broadly speaking there are two main types:

  • Easy-access savings accounts
  • Regular savings accounts

Easy-access savings accounts

If you want to involve your child in the saving and spending process than an easy-access savings account could be a good choice. It means kids can add and withdraw money from the account whenever they like.

Interest rates tend to be variable and lower than that of regular savers and fixed-rate accounts, but ideal for your child to engage with their account.

Regular savings accounts

Regular savings accounts tend to offer better interest rates but require monthly deposits, typically between £10 and £100 per month, rather than simply a one-off lump sum deposit.

Regular savings accounts tend to offer limited access, fixed rate of interest, and sometimes banks reduce the interest rate if regular payments are missed

Junior ISA

Junior ISAs were introduced in 2011 to replace the government-subsidised Child Trust Fund (CTF) scheme. Unlike Child Trust Funds, Junior ISAs do not include an initial government payment, but are a long-term, tax-free savings accounts for children.

How much can you invest in a Junior ISA?

There are two types of Junior ISA. you can save up to £4,368 in the 2019 to 2020 tax year in either Cash or Stocks and Shares ISAs.

Cash Junior ISA

With a Cash Junior ISA pay no income tax on the interest earned. As of February 2019 cash ISAs offer an interest rate below 3%, meaning a £4,368 annual saving could result in interest of less than £130 – nothing to write home about.

In most cases you won’t pay tax anyway, but current accounts have top interest of 3%. Fixed saving secures the best savings rates.

Bear in mind, though, that interest on the cash held in a Junior ISA will be permanently free of income tax, even into adulthood – regardless of what other income the account holder earns that particular year.

Stocks and shares Junior ISA

Stocks and shares JISAs offer the opportunity to save for a child’s future by investing in the markets. Capital growth and dividends generated is free from capital gains tax.

Just like their cash counterparts, £4,368 can be paid into a stocks and shares JISA in the 2019 to 2020 tax year. One of each account can be opened for each child each year by a parent, provided the child is under 18.

Control of the funds in a Junior ISA passes to the child when they turn 16, which means they can then make their own investment decisions or change providers. The money can’t be withdrawn until they reach 18, however. At this point, it is entirely up to them – in legal terms – how to use this money.

At age 18 the Junior ISA becomes an adult ISA and retains its tax-free status. Because of their typically long-term nature, Junior ISAs are generally better suited to goals such as helping your children pay university tuition fees, or to use as part of a deposit on a first home.

Your own ISA

Saving for your children in your own cash or stocks-and-shares ISA could be an attractive alternative to a Junior ISA. With the current annual ISA limit standing at £20,000, it is certainly possible to save or invest more – but this will mean limiting the amount you can save for your own purposes.

While the tax benefits are the same as for Junior ISAs, money can be withdrawn from a standard ISA at any time – which could be a good or a bad thing, depending on your point of view. If you are saving for your children’s school fees, for example, you may need to have access at a much earlier age than 18.

And there is no point at which the contents of the ISA become the legal property of your child, which could be a selling point if you have concerns about whether the money will be used wisely.

Advantages:

  • Tax benefits.
  • Early access is possible.
  • Control remains with the parent.
  • Choice of cash or investments.

Disadvantages:

  • Saving for your child will reduce the amount you can save for other purposes.

Premium Bonds

Parents or other relatives can save for children while adding a bit of excitement with Premium Bonds: these are issued by the government-backed bank National Savings & Investments at a cost of £1 each (although there is a minimum holding level of £100).

The money held in Premium Bonds does not earn interest: instead, bondholders take part in a monthly draw to win tax-free prizes of between £25 and £1 million. On average, these prizes mean that bondholders effectively earn an annual rate of interest that currently stands at 1.4% – considerably less than is currently available on the best children’s savings accounts or Junior ISAs.

That means that someone with £2,000 in Premium Bonds will, on average receive prizes worth £28 a year – although the actual amount you win could be lower or, on rare occasions, much higher.

Advantages:

  • There is an element of fun and excitement in checking whether you have won a prize.
  • Prizes are tax free.

Disadvantages:

  • You are likely to make relatively low returns, and could even end up with nothing in any given year.

A child’s pension

If you want to take a really long-term approach, you could consider setting up a pension for your child – perhaps alongside one of the savings vehicles described above.

Up to £3,600 a year can be saved on a child’s behalf in a self-invested personal pension (SIPP). But because tax relief can be claimed on pension contributions, this amount of pension will only cost £2,880 – or £240 a month.

In general, children’s pensions are designed to be invested in the stock market and related assets (see “Cash versus investments: The importance of your timeframe”, below). Like any other pension, the money can not be accessed – without incurring significant tax penalties – before the age of 55. But the potential returns than could be achieved over a period of half a century or more are considerable – although they are not guaranteed.

Advantages:

  • Tax relief is paid on contributions.
  • The fund has a long timeframe in which, potentially, to grow.
  • Your child will probably thank you – eventually.

Disadvantages:

  • The money can’t be accessed until age 55, which means it probably can’t be used for university fees or a first property purchase.
  • The tax treatment of pensions may change in a negative way in future.

Cash versus investments: The importance of your timeframe

One of the key decisions relating to saving for children is whether to hold the money in cash – in some form of bank deposit account – or in stock-market linked assets such as shares or investment funds.

Since the financial crisis of 2008, interest rates in the UK, as well as many other countries, have been particularly low. Returns on savings accounts have generally only been a fraction higher than inflation – if at all.

But while cash in deposit accounts may not be earning much interest at the moment, it is guaranteed not to lose value. When you put money in shares or investment funds, on the other hand, your potential returns are greater – but at the same time there is no guarantee that you won’t lose some or even all of your money.

The received wisdom is that stock market-linked investments are more suitable for longer-term saving – with a typical timeframe of at least five years. This gives investors a better chance of riding out any early losses or volatility in their portfolio.

If, on the other hand, you might need to access your funds within a year or two, cash is likely to be more suitable as your capital is effectively guaranteed even if your returns are not (the first £85,000 held on deposit per person per banking group in the UK is protected by the government-backed Financial Services Compensation Scheme, which kicks in if the institution in question gets into difficulties).

There are steps you can take to reduce the risk your investments face: buying a wide range of shares, for example through an investment fund, increases the diversity in your portfolio. This diversity can reduce the risk of sudden sharp falls in value because the various shares are unlikely all to fall in value at the same time. You can also opt to invest in businesses that are considered less risky – such as larger, longer established firms rather than start-ups.

However, if you are putting money aside for the best part of two decades, as will often be the case with a Junior ISA, it is well worth considering holding at least some of the money in the stock market given the potentially higher long-term returns that are available.

Do children pay tax?

Most people don’t realise that children have the same personal tax allowance as adults under the age of 65. This is £12,500 a year for the 2019 to 2020 tax year. The difference is that most adults use up their tax allowance with the first £12,500 of their income.

For children this is obviously rarely the case. So as long as their 'annual income' is less than this threshold then they wouldn't pay tax. For example: £200,000 in a savings account earning 5% each year interest provides £10,000 income which is below the child's tax threshold.

Tax on money given to children by their parents or relatives

A different rule applies however if a parent or step parent puts money into a child's savings account. In this case, 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 the child’s 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% each year 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.

Note: We take care to ensure Talking Finance content is accurate at the time of publication. Individual circumstances can differ so please don’t rely on it when making financial decisions.