Investing for Children

Lots of our clients ask us how they can best invest for their children or pass down wealth to future generations.

Lauren Peters, Senior Adviser at Fiducia Wealth Management, joined the Investors Chronicles team over at the FT for a podcast to discuss the best options, including Lifetime ISAs, gifting and the pros and cons of paying off student loans early.

Lifetime ISAs

Those aged 18+ can benefit from a government tax boost towards their first property by investing in a Lifetime ISA, which can be credited by a parent or grandparent.

The maximum annual contribution is £4,000 and receives a 25% uplift from the government, turning £4,000 into £5,000.

Assuming the maximum contribution is made every year, after 10 years the account will have received £10,000 in tax relief and will be worth £50,000, before accounting for any fees or growth.

The LISA is a hybrid ISA/pension account, offering tax relief in the same way as pension contributions, but with tax-free withdrawals like an ISA.

There are rules around how this kind of account can be used, of course. The balance can be used towards a deposit on a first home, but the maximum value of the property cannot exceed £450,000.

Importantly, if the money is not used the purchase a property, the account holder has the option to delay withdrawing anything until they are age 60 or they can elect to withdraw earlier, but suffer a loss of all of the government bonuses.

Gifting

There are numerous ways to gift money but care must be taken as many of them can impact upon your own Estate for Inheritance Tax purposes.

The Annual Exempt Allowance is a rule enabling people to gift £3,000 per year to one person without this being drawn back into their Estate and, where this allowance was not used in the previous tax year, it can be rolled over to give you a total of £6,000 available to gift to someone.

Lots of people are aware of the seven year rule for gifting, which is technically known as the Potentially Exempt Transfer rule. Here, it is possible to gift money with no limit – and we often see this where parents wish to gift, say, £50,000 to a child towards a deposit on a property.

However, if the giftor does not survive the gift by at least seven years, the value of the gift will be brought back into their Estate for Inheritance Tax purposes.

A lesser known rule is the Gift out of Normal Expenditure rule. Individuals are permitted to gift as much as they like to another person without the gifts ever being brought back into their Estate, as long as certain criteria is met. The criteria is that the gift must come out of income, losing the income must not affect their standard of living and it must be a regular payment. It’s worth also keeping a record.

Student Loan Repayment

The government has dressed this up as a graduate tax, but is this really true? For young adults who took out a student loan under Repayment Plan 1 (those who started their course before September 2012) the current interest rate of the loans is 1.75% per annum, which is less than inflation.

However, for those people unfortunate enough to have started their course after September 2012, their loans come under Repayment Plan 2. This is a plan that applies a standard interest rate in line with inflation as measured by the Retail Prices Index to all loans – currently 3.3% p.a.

Yet, for individuals who earn more than the current threshold of £25,725 a year, they will pay an additional variable rate of interest on top so that once their earnings exceed £46,305 a year, the interest rate is RPI plus a further 3% a year, so currently 6.3%.

Graduates from very wealthy backgrounds are likely to have had their student loans paid off for them, which means the ‘graduate tax’ does not apply to them, others will never earn enough to repay the full loan before it’s eventually cancelled.

For some, however, who are from poor and middle class backgrounds who have managed to beat the odds onto a well-paid job, they will end up paying the bulk of the so-called ‘graduate tax’ as, in the worst-case scenario, they could end up paying back double what they borrowed. It’s a case of the ‘squeezed middle’ here!

When it comes to paying back student loans early, if your child has reached that £46,305 threshold, it’s worth considering repaying the loan early to save them from years of paying this additional rate of interest on top of inflation.

Be aware though, if your child suddenly loses their job and can’t find another one at the same pay level, you won’t get a refund. You have to be prepared to lose the cash.

Repayment Plan 2 is problematic, not just because it hits a certain group of graduates harder than the rest, taking 0% of the ‘tax’ from the very wealthiest people and 100% of the ‘tax’ from the rest, but also because it contradicts everything we know about credit risk.

Ordinarily, the more likely you are to repay a debt (the better your credit rating) the lower the rate of interest that applies. Conversely, where a person is at risk of defaulting on the debt by never paying it off in full (the worse their credit rating) the higher the rate of interest that applies. Here, the opposite is true as those with the highest earnings and, therefore, likely to pay back what they borrowed and more, are hit with the punitive additional interest rate.

You can listen to the full podcast, which also discusses US equity, here: here