MONEY COMMENT
Children Can Make Gains Too

By Cliff D'Arcy
October 8, 2003

In between celebrations and hospital visits, I've been thinking about investing for children this week. That's because my wife had a daughter on Sunday, so I'm putting together a basic financial plan for our newborn.

Of course, it includes the usual stuff: getting her birth certificate, opening two savings accounts (one for gifts from us; the other for gifts from others), finding a suitable stock-market investment, and so on. You can read more about these subjects in the three links at the bottom of the page.

However, at the moment, I'm thinking about how to use my baby daughter's future annual Capital Gains Tax (CGT) allowances - the current allowance is £7,900 for this Tax Year. Used carefully, these can dramatically lessen the tax on gains - even reducing it to zero. Interestingly, it's amazing just how many parents believe that children cannot invest in the stock market and, hence, are surprised to learn that children are entitled to their own CGT allowances.

Parents can make gifts today for the benefit of their children, with the aim of using the children's future CGT allowances. There are two main ways of doing this:

1. Discretionary Accounts

An investment is made in the parent's name, but held for the account of the child. The parent remains the legal owner, with the child being the beneficial owner. This means that the child will be taxed on any capital gains on disposals.

2. Bare Trusts

This is a legal trust, under which the parent owns the assets as trustee for the benefit of the child. When assets come to be sold, any capital gains will be taxed as the child's. These are often preferable to discretionary accounts, because they allow more flexibility as to how the fund can be used for the benefit of the beneficiary.

Bear in mind that, in both cases, the child can demand the trust fund be paid to him/her as soon as s/he reaches 18. This means that s/he could go on to splurge these hard-earned savings on a worldwide binge, instead of using them to pay for university or a deposit for a home!

By using growth-orientated investments such as those investment trusts, unit trusts and OEICs that do not generate income, you can generate useful gains to offset against your child's CGT allowance.

Here's an example:

Mrs Foolfan has just had a son. She and Mr Foolfan decide to give the lucky little mite £15,000 in a bare trust that buys shares in a growth unit trust. The fund grows by 9% a year for eighteen years, producing a total of £70,757. Young Master Foolfan cashes in half of this sum on 5 April and half the following day, using two CGT allowances in the process.

Here is the rather tricky CGT calculation, assuming that the CGT allowance rises by 3% a year, reaching £13,449 after 18 years and £13,852 the next year:

Disposal proceeds:                 £70,757
Minus initial investment:         -£15,000
Gain:                              £55,757

Minus taper relief at 40%:        -£22,303
Gain after taper relief:           £33,454
Minus annual allowance (5 April): -£13,449
Minus annual allowance (6 April): -£13,852
Taxable gain:                       £6,153

It's likely that Master Foolfan won't have to pay any tax whatsoever on this gain, as he also has two years' income tax allowances to use before paying tax (assuming that he has no other sizeable sources of taxable income over these two tax years).

So, off goes Master Foolfan to college, armed with £70,757, which may just about cover the cost of three years at a good Uni in eighteen years' time!

More: A Great Man's Advice On Saving | Making Your Kids Pay Their Way | How To Make Your Kids Rich.