By using their tax allowances wisely, parents can make their children millionaires while they are still in their 30s - and cut a large part of their own inheritance tax burden.
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| In the money: You're unlikely to make your child as rich as Hilton heiress Paris, but you could provide a £1m pot with generous saving and tax breaks |
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Of course having money in the first place helps – but there are just three basic steps and if you can take them, your child should be a millionaire by their 38th birthday.
Tom McPhail at IFA Hargreaves Lansdown says: 'If you have the money to do this it is an extremely tax efficient tactic. It has the double benefit of going some way to helping your IHT bill and your child's pension planning.'
Step 1: Child Trust Fund (CTF)
Your child is eligible for a CTF if he or she was born after 1 September 2002, and entitled to child benefit. The Government provides you with a voucher worth £250 (£500 for low-income families) shortly after the birth plus another £250 (£500) at the age of seven.
Parents, relatives or friends can top up a child's CTF account up to a maximum of £1,200 every year and children cannot access their account until their 18th birthday. The returns are tax free.
There are three types of CTF: cash-only accounts, stocks and shares CTFs, and stakeholder CTFs, which also invest in the stockmarket but have charges capped at 1.5% per annum.
To help make your child a millionaire, you need to opt for an equity (stocks and shares) CTF. By putting away the maximum amount of £1,200 every year for 18 years, as well as the £250 voucher given at birth and the top up at age seven, assuming 6% average growth net of charges for the life of the fund this should generate a total sum of £40,025.57 when your child hits age 18. Do your own calculation.
Anna Bowes of AWD Chase de Vere, an independent financial adviser, says: 'In terms of non-stakeholder CTF offerings, The Children's Mutual (TCM) has the most choice under one roof and offers access to some great non-stakeholder funds from Invesco Perpetual, Gartmore, Insight and UBS, including the Invesco Perpetual Income Fund and Gartmore Cautious Managed.
And the Children's Mutual has a dedicated administration centre and has links with a number of High Street chains including Mothercare and Boots. There is also a Shariah-compliant CTF via TCM.'
In addition, the Co-op has an ethical stakeholder and HSBC offers its UK Growth and Income Fund at stakeholder terms – so nil initial charges and 1.5% max annual management charge.
Step 1 value: £40,025.57
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Step two: Make cash gifts
Another way to boost your children's wealth and reduce your IHT bill is to make cash gifts.
You have to survive for seven years for most gifts to escape the IHT net. Unlimited gifts up to £250 a person per tax year are exempt, as are payments up to £5,000 for wedding gifts.
But what is even better is that regular gifts, of any amount of money, once made from normal income can be exempt from IHT. You must however show that you have been giving regularly and that your standard of living has not deteriorated as a result.
Remember though that HM Revenue & Customs will demand details of these gifts when the giver dies.
The Revenue also allows you to 'gift' £3,000 every year to an individual. So to build up the millionaire fund you need to donate £3,000 to your child from birth and ensure the cash is invested in an equity unit trust. Assuming average compound growth of 6% per annum, this should be worth £409,267 by the time year child reaches age 38.
Adding in the £40,025 built up in the CTF when your child reached 18 would boost this pool of money to some £537,634.
Recommended equity unit trusts include Invesco Perpetual High Income, Gartmore Cautious Managed and Neptune Balanced. The latter two funds invest in a mix of equities, bonds and cash.
Step 2 value: £537,634
(including CTF re-invested)
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Step 3: Pension planning
The major boost to the millionaire fund comes from setting up a pension for your child as soon as they are born. Often parents do not realise that they can do this.
But by setting up a simple stakeholder pension plan for your offspring you can start tackling your child's pension from day one and help reduce your IHT bill, all with the Government's help.
In the past fortnight Helen Blackburn at financial adviser Oaklands Wealth Management has dealt with three clients wanting to set up pensions for their children – the youngest was just seven months old.
Blackburn says: 'There is a bad pension problem now in the UK and it will get worse for future generations. Parents want to know what they can do today to help their children while they are young.'
With effect from April 6, when the 2008/2009 tax year begins, the basic rate of tax will fall to 20% from 22%. A parental contribution to a child's pension will need be £2,880 (attracting tax relief of £720) to maintain the gross maximum annual investment level of £3,600.
If you put the maximum allowance into a stakeholder pension from the year your child is born, again assuming 6% compound growth, the pot will grow to a value of £491,120 by age 38.
Step 3 value: £491,120
GRAND TOTAL: £1,028,754
Therefore, between the CTF, regular cash gifts made and invested, and the pension pot you will provide your child a combined fortune of more than £1m, and all before they reach 40 years of age. They will not, of course, be able to spend all that money because the pension element will be locked away until age 55.
Gerry Brown, a tax expert at life company Prudential, says: 'This tactic is becoming more popular, even if you just contribute from time to time it will still have a very large and positive impact on your child's wealth later on in their life.
'You are getting tax relief on your contributions – it is a nice tax planning exercise. And because your child won't be able to touch the pension until they are 55 years of age you know it is not going to be squandered.'
The two most popular stakeholder pensions at Hargreaves Lansdown are from Axa and Scottish Widows.
McPhail adds: 'Given that parents using such a strategy will be investing for such a long period it would make sense to pursue a bold investment strategy and invest in equities - don't be cautious.'
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WANT TO KNOW MORE?READER COMMENTS (11)
6% net return over 18 years! don't know any unit trust or other
investment vehicle that would give you this consistently. By the time
all the fund managers have had their slice of your cake there's usually
little left. Some trusts or mutuals may give you 6% for a year or two
but every few years the stock market falls and they falls by twice as
much in percentage terms ( usually around 40 %). Then your money is
back to square one but you hold on in hope! Funds and unit trusts are
good to invest in for 2-5 years max, then it's time to get out while
the goings good. If you want to invest for longer then property is the
only way.
Really
though, our financial system never does savers any justice. You're
better off spending the money and let the kids earn their own. The
upside of this stratagy is the less you have, the less tax you have to
pay.
- Aj, bromley
One other thing that I often gripe about is, why do householders have
to contribute approximately £500.00 yes you read it right £500.00 + in
sum cases to the police and fire services pensions via your council tax
when most people cant even afford to pay for one them selves,
approximately half of your council tax goes to funds these. And they
only work in the fire department a maximum of 26 years service not
quite sure about the police, but are nowhere near my 52 years in the
building trade. Ok they do sometimes a great job why should I work for
someone else’s pension.
- Ap, Staffordshire
6% interest per annum is optimistic, particularly as any
income/interest on a child's savings outside of NSI or CTF investments
are taxed at the parent's tax rate.
- Kath, London
I agree with Jim, what Gordon Brown has done to pensions doesnt make
anyone want to save for the long term. Who knows what credit crisis
will swallow our hard earned (and taxed) savings - plus inflation is
huge as Ruth says. Equitable Life killed that one off, my parents
retirement is now seriously less comfortable than it used to be - yet
we can bail out Northern Rock - I dont get it, I dont trust Crash
Gordon and I cant wait for Labour to get kicked out for at least 10
years. Please, as a nation lets stop being so celebrity politician,
greedy, house obsessed, step on the less well off, nasty people - let
get back to good old fashioned prudence. And someone bring back Ming
Campbell to be our PM, we need someone sensible and honest at the helm.
- Greedy Btl'S Ate My Neighbourhood, London
Have an agreement with each of your offspring who do not pay into a
cash ISA for you to pay into it BUT is still available to you if it
should ever be necessary. To hell with IHT !
- Ben, Newcastle
Nice headline, but you've ignored key considerations such as the fact
that income which a child earns on money given to the child by a parent
is subject to income tax in the parent's hands, if the income from that
parent's gift exceeds £100 in the tax year. Plus, unless you and your
spouse annually use up all allowances for ISAs and other tax-privileged
investments, have already made adequate provision for your child's
upbringing and education and your own retirement, have insured your
health and ability to earn a living and have secured the roof over your
head, is it really sensible to tie up your capital in a pension fund
which neither you nor your child can access for 50+ years, all for the
relatively marginal day-one free kick of basic rate tax relief of
£1,200?
- Peter, London
What about the effects of inflation? I was left £800 in 1957, enough to
buy a 3 bed semi. My father invested it and when I turned 18 in 1974
the proceeds were barely enough for a deposit on the same semi.
Similarly, £100K life cover in 1980 seemed a fortune, mortgage paid off
plus capital to fund the children. Now, when I am more likely to
trigger a payout it will barely cover the mortgage.
- Ruth, Manchester
The guide is good but i'll be happy if my daughter have at least
£15,000 by the time she is 18. She can be a millionaire in her own time.
- M Stoker, Milton Keynes
How many 18 year olds with £40k are going to invest it wisely?
- Rob, Bristol
How many people on average salaries can afford to invest over £12K per
year after paying their own living costs and saving for their own
pension?
- Andy, Manchester
It's as easy as that...hopefully the unit trust won't invest in Marconi or Northern Rock shares.
- Jim, Belfast
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