Parents unaware they’ll be hit with tax for their children’s savings

by | Feb 6, 2024

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  • Only a fifth of parents understood how tax on their children’s savings interest works
  • Another fifth of parents incorrectly thought the savings interest was always tax free
  • Parents could be hit with a tax bill once child’s savings interest reaches £100
  • Just £1,900 of savings could land parents with a tax bill
  • Limit should be increased to £500 a year, to account for higher savings rates

Laura Suter, director of personal finance at AJ Bell, comments:

“Parents are unknowingly sleepwalking into a surprise tax bill as they aren’t aware they could be taxed for their children’s savings. Just a fifth of parents correctly identified that they might face a tax bill for savings under their child’s name that are not in an ISA account. Half of parents had no idea how tax worked when it came to the interest earned on their children’s savings. Equally worryingly, a fifth of parents thought that any interest from their child’s savings account was tax free – which is not the case. 

Most parents don’t expect to be hit with a tax bill if they save for their children, 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 tax rule while savings rates have been abysmally low, but now they are creeping up they could find an unwelcome letter from HMRC landing on their doormat with a bill for unpaid tax. And you don’t need to have a huge amount in savings to reach that crucial £100 limit. The top children’s easy-access account pays 5.25%, which means that once you have £1,900 saved you’ll hit that limit. 

Junior ISAs are one way to get around this tax problem, as all the money saved in a Junior ISA is tax free. However, even those aren’t well understood by parents. While just over two-fifths of parents correctly identified that all the interest on savings in a Junior ISA is tax free, another two-fifths admitted they don’t know how tax works on the accounts. One in 10 parents thought that the savings interest in a Junior ISA would be taxed over a certain limit, while 2% believed all of the interest in a Junior ISA was taxed. 

This lack of understanding once again highlights the need for ISA simplification, as the large number of accounts and complexity involved clearly presents a barrier for savers to fully understand the accounts. The chancellor could use the upcoming Budget to simplify the ISA system and build upon the very modest reforms he announced in last year’s Autumn Statement.”

 
 
Which, if any, of the following statements around non-ISA children’s savings are true?
 TotalParentNon-parent
The interest received on a child’s savings not in a Junior ISA is taxed over a certain amount18%20%14%
The interest received on a child’s savings not in a Junior ISA is tax free17%20%11%
The interest received on a child’s savings not in a Junior ISA is always taxed4%5%3%
None of the above are true6%6%6%
Not sure/don’t know55%49%66%
Source: AJ Bell. Based on a nationally representative sample of 2,000 UK adults, with survey carried out online between 26 January and 30 January 2024 by Opinium.
Which, if any, of the following statements around children’s ISA savings are true?
 TotalParentNon-parent
The interest received on a child’s Junior ISA is tax free37%43%29%
The interest received on a child’s Junior ISA is taxed over a certain amount9%12%5%
The interest received on a child’s Junior ISA is always taxed2%2%2%
None of the above are true5%5%6%
Not sure/don’t know46%39%58%
Source: AJ Bell. Based on a nationally representative sample of 2,000 UK adults, with survey carried out online between 26 January and 30 January 2024 by Opinium.

How tax on children’s savings works

“If you reach £100 in any given tax year 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.”

 
 

How to beat the tax hit

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, so any money paid into the accounts by grandparents, other family or friends doesn’t count towards the 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 a Junior 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 4.95% – so slightly lower than a non-ISA account. However, often ISA rates are far 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 an 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 02/02/24.

Tax hit on your child’s savings
Child’s savings potInterest earnedTax cost – basic rateTax cost – higher rate
£3,000£158£32£63
£5,000£263£53£105
£10,000£525£105£210
£20,000£1,050£210£420
Source: AJ Bell. Figures assume interest rate of 5.25% on child’s savings, that the money has been entirely contributed by parents and that the parent has already breached their Personal Savings Allowance.

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