Jordan White DipPFS
Which ISA is best for your child?
You’re probably familiar with an ISA. It’s an incredibly useful savings tool (ISA stands for Individual Savings Account) that provides tax-free growth and tax-free withdrawals.
If you’re thinking about helping your child save for the future, an ISA is naturally a great place to start. But, depending on your financial situation and intentions for your children, which type of ISA could be right for your family?
Picking the type of ISA
Firstly, there are a few questions to ask yourself
1) How much control do I want over the money I’m giving to my child?
2) Are my/our own finances in order?
3) How old is my child?
Control of the money
In terms of money control, you really have two options.
If you’re confident that your child will use the money you give them for sensible things, then a Junior ISA is a good option.
This type of ISA, commonly known as a JISA, is available to children under 18 with an annual allowance of £9,000. If under 16, a parent must be the named account manager. But don’t be fooled into thinking this gives you control over what your child can do with the money.
At 18 years old, any money in the JISA can be withdrawn by the child only.
If you’d rather have control over the money you want to set aside for your child, then simply consider putting extra into your own ISA, assuming you have enough annual allowance (currently £20,000).
When the time comes to give your child money for something, say university fees, you can withdraw it from your ISA and know that the money is being used for its intended purpose.
I can’t stress this enough…think about how much control you want your child to have over money you’re giving them.
Prioritising your own finances
Naturally, lots of parents like the idea of starting a little pot for their child’s future. Before you jump into a JISA, think about your own financial situation.
Have you got cash reserves to draw on in unexpected situations? Because you could end up in a situation in the future where you need to draw on cash and find yourself coming up short. And the money you’ve been paying into the JISA will be locked away. A JISA might last 18 years…a lot could happen in that time.
If you still want to include setting some money aside for your child as part of your monthly/annual spending, then increasing contributions into your own ISA is a more flexible option. That said, it does require discipline. You could be tempted to spend it on non-essential things in the future – new car, holiday etc, rather than rely on it solely for emergencies.
If you’re fortunate enough to use up your annual ISA allowance, then a JISA allowance gives you an extra £9,000 to think about.
The age of your child
In terms of your child’s age, let’s not simply assume they’re under 18.
Lots of parents are looking to help their children into their 20s and 30s, particularly with getting on the housing ladder. That’s where a Lifetime ISA could be a great option.
The main attraction of a Lifetime ISA is a generous 25% bonus added to your contributions by the government. You can open a LISA between the ages of 18 and the day before you turn 40, and continue contributing until the day before you turn 50. So even if your child, now a young adult, isn’t thinking about buying a property, you might like to persuade them to open a Lifetime ISA and give them money to put into it to start building their deposit early.
Maximum contributions are £4,000 a year, meaning the maximum bonus is £1,000 a year.
So, if you’re looking to help a child buy their first home, giving them cash to put into their LISA could really give them a boost.
You won’t be able to open one for your child, so you’ll have to give your child money for them to then pay into their LISA.
The Lifetime ISA does have lots of rules and restrictions so do your research.
So that’s 3 types of ISA:
1) Junior ISA
2) Adult ISA
3) Lifetime ISA
Within all of these are two common ways to hold the money – in cash or in stocks and shares.
Picking where to keep the money within the ISA
Once you’ve decided which, if any, is right for you and your child, you then need to decide how you want to use that money.
A couple of questions to now ask yourself:
1) When will I need to access the money?
2) How much risk do I feel comfortable taking with the money?
Cash ISAs used to be a great way of earning tax-free interest. But since changes to the tax rules on interest earned in regular bank accounts, Cash ISAs have become somewhat redundant. You can get better interest rates from bank accounts.
In reality, only the Lifetime Cash ISA, with effectively a 25% interest rate thanks to the government bonus, would be a good cash option.
Cash ISAs are considered very low risk in terms of the security of the actual money – a bank going bust, for example. That said, with interest rates being low and inflation high at the moment, the main risk of a Cash ISA is that its value in real terms will be reduced by inflation. So, let’s say you have £1,000 in your Cash ISA. The interest rate is 1%. Inflation is 3%. To maintain your spending power, you need your ISA to be worth £1,030 to match inflation. If it only grows to £1,010, you’re £20 worse off in real terms despite being £10 up on paper.
Stocks and Shares ISAs, also called Investment ISAs, allow you to invest in the stock market. Investing in the stock market is considered a good hedge against inflation i.e. generating returns above inflation. But to protect yourself from falls in the stock market, its best to have a long-term approach to this investment.
The general rule is only invest in stocks and shares if you don’t need the money in the next 5 years.
And even then, that doesn’t simply remove the risk. The stock market experiences up and downs. It’s just how investments work. Making money from the stock market is never guaranteed. It requires you to have the right investor behaviour, the right timeframe and the right mix of investments.
With a JISA, if you start early enough, you have a long timeframe – up to 18 years. This is where you could really see the benefits of investment returns over the long term.
With a Lifetime ISA many young people plan to buy a property in the next few years, so a Cash Lifetime ISA would often be the sensible option. But if you were looking closer to 10 years, a Stocks and Shares Lifetime ISA could be a more appealing option for boosting returns on top of the 25% bonus.
An ISA is at the heart of good financial planning, so its a great option when thinking about building wealth for your child's future.
That said, don't put money into an ISA without doing your research and understanding the rules that come with each type of ISA.