UK Taxes and Child Savings – CGT and Inheritance Tax

Written by admin on March 9th, 2012

Article by Stuart Mitchell

Having looked at the most salient example of a tax that savings vehicles such as the Junior ISA are exempted from under their tax free status – that of Income Tax – the second part of this article addresses the other two principle types of UK tax that private investors and savers can be affected by, Capital Gains Tax and Inheritance Tax, and their relevance to child savings.

Capital Gains Tax

The purpose of Capital Gains Tax (CGT) is to raise tax on any profit made on any ‘thing’ (i.e., an asset or property, in the more generic sense) when it is disposed of by an individual or company. The idea of the disposing of an asset will usually refer to it being sold but can also cover donations or exchanges. CGT is levied on the total aggregate profit made on all such disposals across the tax year and only for the amount of that profit that exceeds the designated threshold/allowance which, for the 2011/12 tax year currently stands at £10,600 (£5,300 for trustees). Profits can also therefore be offset by any loses that have been made in the same tax year and even, if they haven’t previously been used, losses from previous years too.

In a simple example, for an individual who sells two assets at £25,000 each and another at £10,000 having purchased them all in the past at £15,000 each, the profit that would be subject to CGT would be £15,000 (£10,000 + £10,000 – £5,000) less the personal allowance of £10,600, i.e., £4,400.

As mentioned above, profits are only subject to CGT if they are not deemed to be income and therefore already covered by Income Tax. However, there are a number of other exemptions which relate to the type of asset that is being disposed of too including an individual’s car, their primary home and any asset which has a value of less than £6,000 when it is disposed of. In addition, alternative sources of wealth such as lottery (etc) winnings and compensation payments are also exempt.

Furthermore, the exemption of some types of childrens’ savings accounts from CGT is often one of the primary tax breaks available to parents saving on their behalf. Specific tax free savings vehicle such as CTFs, Junior ISAs and NS&I (National Savings & Investments) schemes are all exempt from CGT on the profits made by the underlying investments (as well as being exempt from any Income Tax as mentioned in the first part of the article).

Inheritance Tax

Children’s Savings accounts are not usually affected by Inheritance tax but it worth taking a quick look at what it is and how it may come into play. In short, it is the tax that is levied on the value of an individual’s estate (i.e., the realisable value of everything that they own, e.g., property, savings, possessions etc less bills) when they die. The tax currently kicks in only when the total value of the estate exceeds £325,000, at which point any amount above that threshold would be subject to tax at 40%. For example, an estate valued at £375,000 would pay tax of £20,000 (£375,000 – £325,000 = £50,000. £50,000 x 40% = £20,000). It is also worth noting that any gifts or donations that the deceased made in the last seven years of their life will be factored into the value of their estate for tax purposes.

As always. there are however some exemptions which will not attract tax and these include donations to spouses, registered charities and established political parties as well as small gifts (less than £250 and/or £3,000 a year and/or from disposable income) made in the seven years before death.

Inheritance tax will only affect a child savings vehicle in a couple of narrow scenarios, either in which the donations made to the plan come from sources other than the donor’s disposable income and subsequently the donor dies within seven years of making the donation, or if the child accumulates an estate valued at over £325,000 and dies prematurely themselves.

In reality tax free child savings vehicles such as the Junior ISA or Child Trust Fund are very useful ways of accumulating savings on behalf of your child and despite the fact that the label ‘tax free’ needs to be qualified to some extent they do offer significant tax breaks to make the saving process far more beneficial.

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