How children's savings and investments are taxed

How children

Children have to pay tax on their savings and investments just like adults. But by taking advantage of tax-free products, personal tax allowances, bare trusts and nominee accounts, their tax bills can be kept to a minimum.

Written by Abigail Montrose on 26 March 2014


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Do children pay tax?

Yes, but like adults they are entitled to a personal tax-free allowance each year (£10,000 for the 2014-15 tax year). This is the amount of income they can have each tax year before they have to pay income tax. As the only income most children have is from their savings (interest) and investments (dividends), not many children are taxpayers. But watch out if you gave your child their savings or investments – you could be landed with a tax bill instead (see below).

In 2015-16, the Personal Allowance is due to increase to £10,500. In addition, the starting-rate band that applies to the next slice of income, provided it is income from savings, will be increased to £5,000 and the starting rate will fall to zero. This means that most children will be able to have up to £15,500 of income tax-free.

There are several children's savings schemes which are tax-free for both children and their parents, such as Child Trust Funds (CTFs) and Junior ISAs (JISAs), but others are not. For more on saving and investing for children, see our guide.

Tax on savings

Interest earned on savings is automatically taxed at the basic rate of tax (20% for 2014-15) before it's paid out. But non-taxpayers don't have to pay this tax. So if a child is a non-taxpayer, by completing form R85 'Getting your interest without tax taken off', you can make sure they will receive interest tax-free.

If tax has already been paid on any interest, you can complete form R40 'Tax Repayment Form' to reclaim this for the child. Both forms are available from the Taxes Helpline (0300-200 3300) and the HMRC website. Banks and building societies also have form R85. You'll have to fill out a separate form R85 for each bank or building society the child has an account with.

The £100 rule

You can save or invest as much money as you like for a child. But if you're their parent or step-parent and this money earns more than £100 a year before tax in interest or other income each year, then the whole of the income (not just the excess over £100) is treated as yours and you will be taxed on it. This does not apply to interest or income earned on tax-free savings or investments (see above).

The £100 limit is for each parent (so the limit is £200 if both parents give money) and does not apply to other family members. So grandparents and other adults can give money to children and are not liable to pay tax if the child earns more than £100 a year in interest from it.

The £100 rule applies to young people until they reach 18 or marry or enter a civil partnership (whichever comes first).

Tax on investments

Children under the age of 18 (16 in Scotland) cannot usually hold company shares, unit trusts, OEICs or investment trust shares in their own name. But an adult can invest in these for them.

You can set up a designated account and hold investments in this for a child. You can do this in either of two ways:

  • On behalf of your child where you are making a gift to them now. The investment belongs to your child and you cannot have it back for your own use. You are, in fact, holding the money in trust for your child. (This is called a ‘bare trust’ or ‘absolute trust’.) Any gain or income (apart from income caught by the £100 rule – see above) is taxed as your child’s. Your child can take over control of the investment from age 18 (16 in Scotland).
  • With the intention of eventually making a gift to your child, but in the meantime, you still own the investment. This gives you the flexibility to hand over the money to the child when you choose, but, as the money is yours until that time, you will have to pay any tax which arises from it.

Trusts

Whether or not a bare trust has been created when you open a designated account depends on your intentions at the time and these will not necessarily be very clear, so you might choose to be more formal and complete a trust document. Investment trust, unit trust and OEIC companies are used to setting up bare trusts and can help you with this. You will either have to fill in a 'declaration of trust' form or a similar form from the company. You should also complete HMRC form 41G (trust) which is available from either the investment company or the HMRC website.

Once the child turns 16, the account must be transferred into their own name before it can be registered again for interest to be paid tax-free. However, children cannot own shares until they are 18 (16 in Scotland) so share-based investments cannot be registered in their name until then.

If you do not want your child to take control of the investment at such a young age (or perhaps you want the flexibility to change who receives or shares the gift), you could consider instead a ‘discretionary trust’. This is a more complex and expensive form of trust and you might well want to take financial advice before going down this route.

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