The challenge: young people face bigger financial obstacles than ever
Young adults in the UK have arguably never faced such daunting financial challenges.
Over two decades, university tuition in England has become among most expensive in the world. Most universities today charge £9,000 a year. Students can borrow their fees but face owing an average of more than £44,000 when they graduate. Government loans, for those who wish to borrow the money to cover their fees, come with interest rates as high as RPI plus 3 per cent. This year that will mean 4.6% interest – higher than most mortgages.
Speaking of mortgages, young graduates will also find getting a toehold in the housing market much harder than the previous generation. The average deposit paid by first-time buyers in 2015 was £32,927 nationwide (a 13% increase)PDF, or £91,409 in London. Even well-paid and well-disciplined young couples struggle to save these kinds of sums in their twenties.
The response: how to provide tomorrow's young adults with a financial leg up
Usually the phrase “nest egg” refers to savings for our own retirements. But in the broader sense it can mean any substantial sum that has been saved or invested for specific longer-term objectives. Parents, grandparents and other interested adults are increasingly looking to help the next generation face the challenges above by storing up a nest egg for them that could potentially save young adults years of hardship and many thousands of pounds in loan interest.
It doesn't have to impose a financial burden either. Because of the generous time horizon and tax shelters available, only a small amount saved or invested regularly throughout childhood can add up to a considerable sum.
Vehicles for saving for a young person's future
Two-thirds of Junior ISA funds are held in cash. One benefit of cash savings, as opposed to investing in stocks and shares, is that up to £75,000 of your money in a bank or building society is covered by the Financial Services Compensation scheme.
However, in our view the tax shelter aspect of a Junior Cash ISA is now irrelevant for young savers. The new Personal Savings Allowance allows savers to earn the first slice of interest tax-free from any account. Unless your child is a higher-rate taxpayer, their savings can earn up to £1,000 in interest each year tax-free, without needing the ISA shelter.
The other thing to beware of with saving cash over the long term is that inflation can erode the real value of cash over time. The only return on this type of account is cash interest, and the rates are puny. Given the government's ongoing inflation target of 2%, it is likely that a long term cash savings strategy will shrink, rather than grow, money saved for a child.
- Up to £4,080 can be paid into a child's Junior ISA in the 2016/17 tax year
- JISAs can hold stocks and shares, or cash savings
- The child can access the account when they reach the age of 18
- Returns, including dividends, interest and capital gains on investments, are free from tax
Junior Stocks & Shares ISA
Investing as early as possible in stocks and shares within a Junior ISA, with capital locked away for as long as 18 years, allows parents to take a long-term approach. The earlier you invest, the longer the stock market can work to deliver returns that can then be reinvested until the money is needed. This is the effect of compounding.
The advantage of the Junior ISA tax shelter will be apparent when the young adult comes to sell their investments, whether they are 18, 28 or older. All gains will be tax-free regardless of their income tax bracket. If their investments were held outside of an ISA, Capital Gains Tax could be payable depending on their circumstances.
If you're willing to take a really long-term view, how about starting a pension for your younger one?
It won't help with immediate financial obstacles of adulthood but it does address the worry that some parents have about giving teenagers too much financial privilege too soon. If you're wary of your young adult having access to their Junior ISA aged 18, a SIPP (self-invested personal pension) offers a different way forward.
It will give them a decades-long head start on saving for their own retirements, and when they start employment they will have carte blanche to maximise their monthly budgets towards repaying student debts and saving for a deposit, rather than needing to start pension contributions of their own.
Like Junior ISAs, the SIPP wrapper shelters investments from Income Tax and Capital Gains tax. Under current rules the young person won't be able to access the money until age 55.
Remember that that the value of stock market investments, and the income from them, will fluctuate. Stock markets fall as well as rise and you may not get back the original amount you invested. Also, tax rules may change in the future and their tax advantages depend on your individual circumstances
Inheritance tax considerations
The earlier you invest for a child’s future, the more tax-efficient it can be for grandparents in terms of minimising exposure to inheritance tax.
- No inheritance tax is due on gifts made at least seven years before death
- Regular gifts, including payments into a savings account, are IHT-free as long as the amounts are within your means
Get advice on investing for children
The options we've discussed above include elements of investing and tax planning. Not everybody is confident taking these decisions into their own hands.
If you are unsure about which approach will best suit you and your children or grandchildren, or which investments would be suitable, you can get detailed recommendations by speaking to financial adviser.
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