Investing for children in a tax-efficient way

With younger generations facing ever higher costs for education and housing, carefully considered help can have a life-changing impact. Indeed, investing for your children or grandchildren is one of the most meaningful financial decisions you can make — and potentially one of the most satisfying.

With time on their side, even modest contributions can grow into significant sums, particularly when combined with tax-efficient wrappers. What’s more, this may also be a sensible way to limit Inheritance Tax — particularly in light of upcoming changes to the rules around tax on pension savings.

This article explores some of the most effective ways to invest for younger relatives. The focus is on UK-based families, but the general principles apply to all. However, it’s essential to seek appropriate advice prior to taking any action.

The power of starting early

Never underestimate the value of starting early when it comes to investing. When investment gains are compounded over decades, relatively small contributions can grow into substantial sums.

This is particularly relevant when using tax-efficient vehicles such as ISAs and pensions, where returns can grow free from Income Tax and Capital Gains Tax.

Junior ISAs (JISAs): a flexible option

A Junior ISA is often the starting point for investing on behalf of a child. With withdrawals typically allowed at the age of 18, this might fund education, a first step on the property ladder or provide support to fulfil some other ambition.

Contributing just £100 per month would build up a sizeable pot by age 18. Anyone can contribute (subject to the provider’s payment rules) up to £9,000 per tax year.

• Growth is free from Income Tax and Capital Gains Tax.
• Investments can be in cash or stocks and shares.
• Funds are generally locked until age 18, when the child takes control.
• Child ISAs automatically convert to an adult ISA.

Some may be wary of providing their child or grandchild with a significant sum at 18, but it’s thought that Junior ISAs can set the tone for long-term investing. In fact, some youngsters choose to continue contributing to their ISA.

As ever, it’s important to note that whilst contributions made in childhood may grow significantly over several decades, returns are not guaranteed and will depend on actual growth and charges. The value of investments can fall as well as rise, and you may get back less than you invest.

Pensions for children: a powerful tool

Pensions for children — often referred to as Junior SIPPs — are one of the most powerful wealth-building tools available. What’s more, the pension would not be accessible until at least the age of 57, so it provides long-term security without the use of trusts.

• Contributions of up to £2,880 per year.
• Basic rate tax relief on contributions, means that the Government adds £20 for every £80 paid in. This means £2,880 is topped up to £3,600.
• Growth is also tax-free.
• Funds are locked until pension age (currently 55, rising to 57 from April 2028).

Trusts: flexibility and tax planning opportunities

While not offering the same degree of tax efficiency as ISAs and pensions, a trust may be the only option for larger sums. Discretionary trusts can also protect funds over a longer period.

Bare trusts

Bare trusts allow assets to be held in a child’s name, managed by trustees until adulthood, with the child able to access funds at 18 (or 16 in Scotland). The child is taxed on the income and capital gains, which is tax efficient as the child has their own allowance and is likely to be in a lower tax band.

However, where the parents make the gift, income over £100 per year may be taxed on the parent. Gifts from grandparents are likely to be more tax efficient for this reason.

Discretionary trusts

Generally used for larger sums of money, discretionary trusts offer greater control. There may be a number of potential beneficiaries, with trustees deciding when money should be paid to a particular individual.

These are generally more complex to administer and are likely to be subject to higher taxes than investments in bare trusts. However, they are particularly useful for vulnerable individuals, and can potentially provide long-term protection in the event of divorce, bankruptcy etc.

Premium bonds: saving with a twist

These shouldn’t be used as an alternative to more traditional investments, but premium bonds may capture the imagination of children and introduce them to the idea of saving.

Premium Bonds don’t pay interest; instead there is a monthly prize draw. The current prize fund rate is 3.30% and the odds are 23,000 to 1 per £1 Bond per month (both variable). Returns are not guaranteed and many holders will receive less than the published prize fund rate.

Inheritance tax considerations

Investing for children is not just about growth — it’s also a valuable estate planning tool.

• Contributions to Junior ISAs and pensions are treated as gifts.
• They may fall within the £3,000 annual gifting exemption.
• Gifts from surplus income: regular gifts from surplus income are immediately exempt from IHT if structured correctly.
• If none of the above apply, gifts usually become exempt if the donor survives 7 years. Tax may apply if death occurs within 7 years and taper relief may apply.
• Rules for discretionary trusts are more complex, and considered professional advice is particularly important to ensure they are tax-efficient. They incur an immediate 20% ‘Lifetime Tax’ charge if contributions exceed the £325,000 nil-rate band, plus 10-yearly charges of c.6% and exit charges.
• Trust taxation depends on the settlor’s prior transfers and the type of trust. The rates above are a simplified overview.

Forming a strategy

A blended approach may be the optimum way forward. For example, a junior ISA offers flexibility and access to funds in early adulthood, while a pension can provide long-term security and investment growth. Starting early and using tax-efficient wrappers can significantly enhance outcomes.

Final thoughts

Whether the goal is funding education, a first home, or retirement decades in the future, a well-planned approach can make a profound difference. Investing for children and grandchildren is about more than financial returns — it’s about creating opportunities, supporting life milestones, and transferring wealth efficiently across generations.

The final word goes to AJB Wealth’s Managing Director. Paul Willans, who agrees: ‘When it comes to financial literacy, we could paraphrase an old adage and say ‘it’s better to teach a child financial literacy, than to just give them money’. Because the greatest gift isn’t the money itself, but the confidence and capability to manage it well during their lives.’

AJB Wealth can help with all aspects of investment and tax planning. To discuss your situation, please book an exploratory meeting, or call us on 01428 774 070.

Important: This article is for information only and does not constitute personal advice or a recommendation. Tax rules are subject to change and depend on individual circumstances. The value of investments can fall as well as rise and you may get back less than invested. Eligibility rules vary by provider and residency status. If you are unsure which option is suitable, take regulated advice.