Parents risk ‘sleepwalking’ into surprise tax bill if child’s savings earn just £100 interest

PARENTS face “sleepwalking” into tax bills triggered by just £100 in interest earned from their children’s savings accounts, experts have warned.

Improved savings deals mean a pot of as little as £1,900 could now result in income tax being levied on children’s nest eggs, assuming an interest rate of 5.2 per cent. This is because once the interest earned on cash gifted by parents reaches £100 a year, parents must pay tax on it if they have already exceeded their own savings allowance.

The allowance lets basic-rate taxpayers earn £1,000 in savings interest a year tax free. For a higher-rate taxpayer, this drops to £500. Additional rate taxpayers do not have a personal savings allowance.

A child’s savings pot of just £3,000 would generate £158 in annual interest. This would cost a higher-rate taxpayer who had already exceeded their savings allowance £63 in income tax, assuming the same 5.2 per cent rate.

A £10,000 savings pot would trigger £210 in taxes, while a £20,000 pot would leave the same taxpayer with a £420 bill, according to broker AJ Bell.

AJ Bell’s Laura Suter said parents had not needed to worry about such tax bills when savings rates had been “abysmally low” but now: “You don’t need to have a huge amount in savings to reach that crucial £100 limit.

“Parents are unknowingly sleepwalking into a surprise tax bill as they aren’t aware they could be taxed for their children’s savings,” she added.

Only one in five parents was aware of the tax rules around saving for their children, according to a survey by the broker. Another fifth assumed their children’s interest was always tax-free.

Parents should know that the £100 limit on tax-free interest only applies to money gifted by them. Any cash paid in by grandparents or family friends is exempt. HMRC advises parents to record payments made by other people in the event evidence is required.

Other tax-efficient options include Junior Isas, Child Trust Funds and NS&I Premium Bonds.

Anna Bowes, of consumer website Savings Champion, said: “Prizes from Premium Bonds are not classed as interest, so they are exempt. Just as well, as it would be pretty shocking for a parent to have to pay tax on a £1million prize.”