Laura Suter, head of personal finance at AJ Bell, comments:
“Parents who diligently save money for their children wouldn’t expect to be hit with a tax bill, but a little-known rule means the taxman could take some of the interest from their child’s savings. Once a child earns £100 or more in interest on their savings account on money that’s been gifted by parents, it’s taxed as though it’s the parent’s money.
“Parents haven’t had to worry about this little-known tax rule while savings rates have been abysmally low, but now they are creeping up they could find HMRC comes calling for unpaid tax. For example, the top children’s easy-access account pays 4%*, which means that once you have more than £2,500 saved you’ll hit that £100 limit. If you opt for a fixed-rate account you can earn even more, with the top two-year fixed rate kids account paying 4.4%* – meaning that once savings reach £2,250 you’ll hit that £100 limit.
“If you reach £100 then all of that interest (not just the interest over £100) is counted as though it’s the parent’s and will count towards their Personal Savings Allowance (PSA). The PSA means that basic-rate taxpayers can earn £1,000 in savings income before they pay tax on it, while higher-rate taxpayers have a £500 allowance. Additional-rate taxpayers have no allowance. If your savings interest plus your child’s is still within your PSA then you’ll have no tax to pay. But if you’ve already used up the allowance (or your child’s savings tips you over) then you’ll have to pay tax on that money, at your income tax rate.
“It’s annoying that parents who have diligently saved for their children might find their good deed has a tax sting at the end of it. The limit is intended to stop parents funnelling their savings into accounts under their child’s name to avoid tax – but the £100 limit is out of date and should be increased to £500. This would prevent parents being caught out and having to report to HMRC for relatively small sums, but would still act as a barrier to parents trying to tax dodge. For now, there are ways for parents to avoid being hit with the tax rule by organising their savings, using alternative accounts or drafting in grandparents.”
Get family and friends involved
“One way around this pesky tax rule is getting friends or family to contribute to the accounts instead. The £100 limit only applies to money given to the child by parents, any money paid into the accounts by grandparents, other family or friends doesn’t count towards the limit, so if grandparents fund the accounts or friends pay birthday money in then you won’t hit the tax limit. HMRC say that parents should keep hold of any evidence that payments have been made by other people, so they can prove it later should they need to.”
Gift from both parents
“The limit is £100 per parent, per child. This means parents should think carefully about how they gift money to their children. If each parent has an account in their own names, they should ensure they are making equal payments to their children, rather than one parent making all the transfers to their child’s savings account – as they could hit the tax limit far quicker. If they have a joint account the money will be assumed as coming 50:50 from each parent.
“Equally if one parent has some of their Personal Savings Allowance remaining, they should be the one to gift the child the money. Any interest from the child will be added to the parents and counted towards the PSA. If the combined sums are still within the tax-free savings allowance, they won’t have to pay any tax on the money.
“If you know you’re going to hit the £100 limit, even with spreading the money between the parents, you should ensure the money comes from the lower taxpayer. If one parent is a basic-rate taxpayer while the other is a higher-rate payer, you should gift the money from the basic-rate payer, as you’ll benefit from a higher PSA and you’ll pay 20% tax on the savings interest rather than 40%.”
Use an ISA:
“The other option is using ISAs, as interest earned on ISA accounts isn’t taxable. You can pay in up to £9,000 per child into an ISA each tax year, which means anyone who has built up decent savings outside an ISA can transfer up to that amount each year. The top easy-access cash JISA account pays 4% – so the same as a non-ISA account.
“However, often ISA rates are lower so you’d have to work out, based on how much you have saved and your income tax rate, whether you’re better opting for the higher paying account and paying tax on the interest, or the lower paying account with no tax hit.
“Alternatively, you could consider investing. Lots of money saved for children sits in cash accounts, but really if you’re saving for 10, 15 or even 18 years that’s the ideal time horizon for investing. Investing is your best bet for ensuring your child’s savings beat inflation over the long term. You can open a Junior ISA in their name, which will become theirs when they turn 18, or you can choose to invest the money in your own ISA, if you have some of your annual limit left.”
*According to moneyfacts.co.uk, accurate to 07/03/23
| Tax hit on your child’s savings | ||
| Child’s savings pot | Tax cost – basic rate | Tax cost – higher rate |
| £3,000 | £24 | £48 |
| £5,000 | £40 | £80 |
| £10,000 | £80 | £160 |
| £20,000 | £160 | £320 |
