If you have any children or grandchildren you may want to open a savings account for them to encourage them to save from an early age. In general, child saving accounts work like adults’ accounts, but some schemes are designed specifically for children.

Do children have to pay tax on savings?

Banks and building societies offer savings accounts just for children. Most adult accounts will usually have 20 per cent tax deducted on the interest before it’s paid, which is the case for most savings accounts.

However, children, like adults have a personal tax allowance of £5,225 for the tax year 2007-2008. This is income they can receive tax-free. As long as their annual income (including interest) is below this amount, they’ll be able to:

  • receive interest without having the tax deducted (parents or guardians fill in a Form R85 for each account)
  • claim back any tax they shouldn’t have paid (parents or guardians make a separate claim to HM Revenue & Customs (HMRC) using Form R40)

A child can’t claim to receive savings interest tax-free if their income is above the personal allowance. But they will be able to reclaim some tax because they have not used the starting rate (10 per cent) tax band (up to £2,230 above the personal allowance).

Giving money to your children or investing on their behalf

You can give a child or invest on their behalf as much money as you like. But if you’re a parent or step-parent and the money you give your child earns more than £100 interest a year, this interest will be taxed as if it were your own.

The £100 limit only applies to parents and step-parents. Grandparents and other adults who give money to children are not liable to pay the tax if the interest exceeds £100 a year.

Inheritance Tax

If you give money to your children or grandchildren (or to children you care for) Inheritance Tax exemptions may mean that tax does not have to be paid on it. If you die within seven years of giving the money there might be some Inheritance Tax to pay.

Tax-free saving for children:

There are a number of savings products which are totally tax-free and available only for children.

Child Trust Fund (for children born after 1 September 2002)

If your child was born on or after 1 September 2002 and is eligible for Child Benefit, you’ll get a £250 voucher from the government (£500 if your income is no more than the limit for Child Tax Credit) to set up a Child Trust Fund. Once you have set the fund up anybody can add up to a maximum of £1,200 a year to it. There will be no tax on any interest or gains.

The Child Trust Fund (CTF) is a long-term savings and investment account and the money cannot be withdrawn until the child is 18.

Children’s Bonus Bonds from National Savings and Investments (NS&I)

NS&I Children’s Bonus Bonds provide tax-free interest for children under 16, with an additional bonus if the money remains untouched for five years.

NS&I bonds are available in ‘issues’ and each issue has its own rate of return. You can invest between £25 and £3,000 per issue, and there could be several issues in a year (normally coinciding with interest rate changes).

Because NS&I Children’s Bonus Bonds are offered by National Savings & Investments they are backed by the government and are a safe way of saving. Application forms are available online or from the Post Office.
Other tax-free savings

Parents and grandparents can also use other tax-free savings products which are available to adults on the behalf of children. As these are not specifically designed for children in some cases you will have to manage the account until the child reaches a certain age.

Index-linked Savings Certificates (NS&I)

You can invest from £100 to £15,000 for three or five years in Index-linked Savings Certificates. The value of the investment is guaranteed to keep up with inflation and the interest rate is guaranteed. You don’t pay any tax at all.

Children under seven need someone else to purchase the certificates on their behalf.

Premium Bonds (NS&I)

An individual, including a child, can own between £100 and £30,000 worth of Premium Bonds.  Interest is not paid on Premium Bonds, but each bond is entered in a prize draw every month and prizes are tax-free.

Parents, grandparents and great grandparents can purchase Premium Bonds for a child, but a parent or guardian must hold the bond on the child’s behalf until they reach 16.

What happens when a child turns 16?
When a child turns 16:

  • they’re responsible for the tax on their interest payments, so they’ll need to fill in their own Form R85 (provided their income stays below the personal allowance)
  • accounts held in someone else’s name should be transferred to them - otherwise the bank or building society will immediately have to start to deduct tax from the interest (it may be possible to reclaim this tax, as described earlier).

Source: DirectGov. Crown copyright.