One of the popular financial myths is children pay no tax – and this urban legend spurs many parents to try and avoid tax by diverting cash to their young families.
The truth of the matter is children pay no tax if they earn less than the personal income tax allowance – which is £11,000 for the 2016-17 tax year.
If a parent tries to offload some earnings to reduce their personal tax burden, if the child is under 16, HM Revenue and Customs (HMRC) will deem the money is still in control of the parent and tax them accordingly.
But if relatives who are not parents give the children cash, the same rule does not apply.
So if the no tax route is closed, what is the best way to give children some cash for a start in life?
Children can have a pension
Family can save up to £2,880 a year – which is boosted to £3,600 by tax relief – in a Junior SIPP.
Figures from financial firm Fidelity International show that if a family saves £3,600a year for 18 years, when the child hits 65-years-old they will have a pension pot of more than £600,000 even if they do not contribute a penny during their working life.
The money is not lost even if they skip the UK and become an expat, because all the cash including the tax top up can be transferred to a tax and investment efficient Qualifying Recognised Overseas Pension Scheme (QROPS).
Another advantage is gifted contributions into a Junior SIPP are likely to fall outside of inheritance tax.
Junior ISAs
If a parent or child wants to access the cash, from 2028 the minimum age from drawing money from a pension rises from 55 to 57 years old.
An alternative is a Junior ISA. Anyone can contribute up to £4,080 a year. At age 18, the fund automatically switches from a junior to an adult ISA.
The child can take the money after their 18th birthday to spend as they wish.
Both Junior SIPPs and ISAs are open to children who are tax resident in Britain – the schemes are not open to expat children, who would receive no tax benefits from making the savings.
