How to Prevent your Children’s Savings from being Taxed

For tax purposes, the government views a child as an independent person who is entitled to a personal allowance of £5,035 (2006/2007) just like any adult. 

However, unlike adults, the vast majority of children do not earn above the personal allowance so therefore their savings are tax-free. For their savings to be non-taxable, you must fill out the Inland Revenue R85. To prevent you from simply dumping your savings into your children’s account, the taxman limits the amount of tax-free interest your gifts can earn.  This limit is set at a maximum of £100 a year for each parent. Therefore, you must be careful not to go over this limit as the government won't just tax the amount that is over the £100 limit, it will charge tax on the whole of the interest.

The £100 limit does not apply if the gift comes from anyone but you. This means that if friends and families want to deposit a “gift” into your children’s accounts, it does not affect your or your children’s taxable allowances.

£100 Rule

As explained above, the government allows your children to earn interest up to £100 without being taxed.  This means that you can invest as much as £2,000 (based on 5%) in each of your children's accounts and it wouldn’t be taxed because the interest earned on that amount adds to only £100.  Because both you and your spouse can earn interest for your children up to £100 each, both of you can invest a total of £2,000 (based on 5%) in each child’s name, earning £200 in interest without this being taxed. If you have two children, you can invest £4,000 each, three - £6,000 each etc….

However, it is important to understand that this does not mean you can invest exactly £2,000 every year. If you do, accumulated interest would go over the threshold maintained by the government.

Friends and Families

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It is important to remember that the £100 rule only applies to you; this includes guardians of stepchildren and adopted children.

However, friends and families are NOT included in this rule. This means that, providing it is a genuine gift, family and friends could give your children as much as they want without worrying about the £100 limit. This is because any interest earned is offset against their personal allowance (£5,035 for 2006/2007 tax year). As long as the total amount of interest falls within this allowance, then no tax will be payable.

Where both you and other relatives are saving on behalf of your children, you should consider opening separate accounts, one for your gifts and one from other friends and families. This helps to separate the two parties.

Children and Inheritance Tax

Even after your death, the taxman can take up to 40% of your tax before your children have received it. You can avoid this by giving:

• to your children or other individuals more than seven years before death 
• £3,000 in any one-tax year, plus any unused balance of £3,000 from the previous tax year (The tax year starts on 6 April in one year and ends on 5 April in the following year.) If you haven’t taken advantage of this before, you can “gift” up to £6,000 as you are able to carry any unused allowances forward from the previous year. If you make regular patterns of giving “gifts”, these are also exempt from tax
• wedding gifts of up to £5,000 to each of your children (including step-children and adopted children) or the person that your child is marrying
• wedding gifts up to £2,500 to each grandchild or the person that your grandchild is marrying
• wedding gifts of up to £1,000 to anyone else
• payments for the maintenance of your spouse, ex-spouse, dependent relatives and, usually, your children who are under 18 or in full-time education 
• outright gifts in any tax year up to a total of £250 each to any number of people, but only if the total of all gifts made by you to the recipient in the same tax year does not exceed £250.

You can make gifts under more than one of the above headings to the same person and they will be free from inheritance tax. For example, to your children in the year they marry, you could give £5,000 as a wedding gift plus £3,000 as another gift, and these would be exempt.

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