INVESTMENTS - 26.11.2010

Are junior ISAs the new Child Trust Fund?

CTFs out, ISAs in

Child Trust Funds (CTFs), the government’s cash handout scheme for children born since August 2002, are currently being phased out (yr. 10, iss. 18, pg. 2, see The next step). Their demise caused a small political storm when it was announced several months back. But now the government has announced that it will be launching an Individual Savings Account (ISA) for youngsters up to the age of 18. Is this just a gesture to placate those losing out on CTFs or a true tax-saving opportunity?

What’s on the label?

The new “Junior ISA” will have similar terms and conditions to the grown-up version:

• investments can be made in stocks, shares and deposit accounts and can be switched from one type of investment to another

• all interest etc. will be tax-free

• there will be an annual investment maximum; this is yet to be announced.

One of the major differences between the Junior and normal ISAs will be the right to access funds. Normal ISAs can be fully or partially cashed in at any time by the investor. But that’s not the case with the Junior versions.

Trap. The investments in a Junior ISA will be locked in until your child reaches 18 years of age, at which point they’ll be entitled to the capital and accrued interest etc.

Future backdating

Although the government has announced the creation of Junior ISAs, they won’t be available to invest in until at least mid 2011. This means there will be a gap of around a year when parents of newborns can neither invest in a CTF nor a Junior ISA. To make sure that these children don’t miss out, the eligibility for the Junior ISA will be backdated for children born any time after the end of CTFs, i.e. from around August 2010.

Income shifting

There are two further major differences between CTFs and Junior ISAs; one’s bad news and the other good. The bad news is that, unlike CTFs, the government won’t be making a direct contribution into the Junior ISAs. The good news is that parents will be able to invest money for their children without having to pay tax on it. Currently, anti-avoidance rules mean that parents who transfer their own money into their child’s name have to pay the tax on interest etc. where it exceeds £100 per year. The Junior ISA will give them exemption from this. You might think that this doesn’t sound like much of a tax break, but shifting investments into a tax-free Junior ISA could really add up.

Example. Assuming the Junior ISA limit when announced is set at £2,000 per year, i.e. one-third of the current adult rate, and you made full use of this for 18 years by shifting £2,000 of your investments to each of your two children, and the interest or return on the money was just 3% per annum, you could save yourself over £12,000 in tax over that period of time (see The next step). And if you were able to get a better return on the investments, you would save even more tax.

For the previous article (TX 11.05.05A) and for a calculation of the tax saving in the example (TX 11.05.05B), visit http://tax.indicator.co.uk.