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Many parents in the UK have a desire to save money for their children, but their ability to do so varies greatly. According to a recent survey, the average savings per child is £561 per year, adding up to less than £10,100 by the time a child turns 18. While this amount can be beneficial for setting the stage for financial well-being for a young adult, it may not be enough to help cover costs like further education or, for the long-term, retirement savings.

Fortunately, parents have several options when it comes to setting aside funds for their minor children, and even a small amount can go a long way when investments and tax-free benefits are added into the mix. The two most common types of long-term savings for children in the UK are Junior ISAs and Junior SIPPs, both which come with benefits and drawbacks of which parents should be aware.

What is a Junior ISA?

A Junior ISA, or Junior Individual Savings Account, is a tax-free way for parents to save for their children. Parents can set aside up to the annual limit, currently £4,260 for the 2018/19 tax year, however, smaller amounts can be contributed as well. The Junior ISA comes in two broad forms, including a fixed-rate savings option or a shares and investment option, both which have advantages and disadvantages to consider.

Benefits

With a Junior ISA, the most significant benefit is the ability to save in a tax-free manner. The funds set aside are not taxed at either the parent’s or the child’s rate, and they stay tax-free even when the money is transferred to the child. Additionally, many financial institutions offer Junior ISAs with fixed interest rates that provide a safer way to save over the long-term. Investment Junior ISAs may have more growth potential over the same timeframe, but there is risk involved as well.

Junior ISAs also allow parents an opportunity to teach their children about money while they are young. A finance specialist from MoneyPug, an ISA comparison site, shares that explaining to children how savings works from an early age gives them the ability to make wiser choices when they are an adult, from a financial perspective. Junior ISA funds can be used for university expenses, for instance, which can keep young adults from starting their financial life with debt.

Drawbacks

While there are inherent benefits to Junior ISAs, one major downside is the fact that the money automatically transfers to the child when he or she turns 18. Without providing some type offinancial education beforehand, a child with a substantial amount of savings at that young age may make poor choices on how to spend the money. Additionally, any savings set aside in a Junior ISA cannot be taken out for another use, so parents need to take care to evaluate how much they can save without limiting their personal or retirement savings schemes.

What is a SIPP?

A SIPP, or a self invested personal pension, is often thought of as a long-term savings vehicle for adults. However, a Junior SIPP can be established for a child, with similar tax benefits as one for an adult. A Junior SIPP also comes in two broad forms – a shares or investment option, or a cash option that accrues a fixed rate of return. The rules around Junior SIPPs differ from Junior ISAs, so parents should take the time to understand them before making an investment.

Benefits

With a Junior SIPP, parents can establish a long-term savings vehicle for their children with tax benefits. Contributions of up to £2,880 are allowed, and a 20% tax relief contribution is automatically added for non-earning children. These savings are free from tax, and they have protections relating to the inheritance tax exemptions that allow for even further growth over time. Junior SIPPs, then, can be a smart way to help a child save for the big financial goal of retirement early on in life.

Drawbacks

While Junior SIPPs can be beneficial, they are also somewhat restrictive. Parents cannot take out contributed funds, and savings are only available without significant penalties when a child reaches age 55. For this reason, SIPPs cannot be used to help fund university costs. Additionally, investing may prove risky over time, as investment returns are not guaranteed.

Making the Choice

Parents should consider their ability to save in a Junior ISA, a SIPP, or another child savings vehicle based on their own financial circumstances each month or year. The ability to receive tax benefits on each type of account is beneficial, but the restrictions can be cumbersome to parents and their children. It is necessary to think through these options carefully before making an investment or contribution.

Brought to you by Jose Calvo.