Children and tax: What you need to know
Children are treated independently for tax purposes. If they earn sufficient income, they are taxed like adults, with their own:
- Personal Allowance
- Basic rate tax band
- Savings allowance
- Capital Gains Tax (CGT) annual exemption
This independence creates opportunities for families to manage income and assets efficiently.
Helping with your grandchildren’s school fees
With the rising cost of private education, many grandparents are considering how they can provide financial support. However, contributing towards school fees can sometimes have tax implications, particularly in relation to inheritance tax (IHT).
Capital transfers made for the education or maintenance of a child under 18 (or over 18 if in full-time education) are generally exempt from inheritance tax only if they are made by a parent (and the child is in their care). This means grandparents do not usually benefit from this exemption.
That said, everyone in the UK has an annual inheritance tax gift allowance of £3,000. You can give away up to this amount each tax year without it being added to the value of your estate for IHT purposes. As a result, two grandparents could together contribute £6,000 per tax year towards school fees without triggering inheritance tax – even if they were to pass away within seven years of making the gift.
Importantly, any unused annual exemption can be carried forward to the following tax year (but only for one year). For example, if no gifts were made last year, each grandparent could give £6,000 this year – a combined total of £12,000 – free from inheritance tax.
There are also additional ways to support grandchildren tax-efficiently beyond the annual exemption. These include:
- Making gifts out of surplus income (which can be immediately exempt from IHT if certain conditions are met), and
- Establishing a trust structure to hold funds for future school fees. You can find out more about Family Trusts here.
Another option is to use ISA allowances to build up savings in anticipation of future contributions. ISAs are exempt from income tax and capital gains tax, making them an effective long-term planning tool. The ISA annual allowance for the 2025/26 tax year is £20,000 per individual. Therefore, if two grandparents each invest the full allowance annually, up to £200,000 could be contributed over five years in a tax-efficient environment.
It is important to note that Lifetime ISAs are subject to different rules, and withdrawn funds cannot simply be replaced without affecting your allowance. In addition, from April 2027 the Cash ISA limit for those under 65 will reduce to £12,000, although the overall ISA allowance will remain £20,000.
Careful planning can ensure that support for your grandchildren’s education is both generous and tax-efficient.
Working in the family business
One legitimate way to utilise a child’s Personal Allowance is to employ them in the family business:
- The work must be genuine, with payment only for actual work done.
- Salaries must be commercially justifiable.
- Minimum wage rules must be followed.
Children can work part-time from the age of 14. In some local council areas, children can work part-time from the age of 13. Children can only start full-time work once they’ve reached the minimum school leaving age – they can then work up to a maximum of 40 hours a week.
Therefore, employing children in the family business can reduce the family’s overall tax liability while also providing them with meaningful, real-world work experience.
Transferring income-producing assets
If a child’s income is low, transferring income-generating assets to them can allow full use of their Personal Allowance.
- Transfers from parents: If income exceeds £100 per year, it is taxed back on the parent.
- Transfers from grandparents or other relatives: These can provide greater tax efficiency.
When planning such transfers, consider the potential Inheritance Tax (IHT) implications.
Top tax tips for grandparents
1. Lifetime Gifts and inheritance tax exemptions
Despite concerns over recent budgets, inheritance tax exemptions remain available to help grandparents support grandchildren:
- Annual exemption: £3,000 per year
- Small gifts exemption: Up to £250 per recipient
- Wedding gifts: Up to £2,500 per grandchild or great-grandchild
- Gifts out of normal income: Exempt from IHT provided they come from surplus income and don’t reduce your standard of living
- Gifts made more than seven years before death: Also exempt and taper relief may apply between years 3 – 7.
These can reduce the value of your estate above the £325,000 nil-rate band, minimising inheritance tax.
Many estates can benefit from the extra Residence Nil Rate Band (up to £175,000) when passing a home to direct descendants.
2. Pension Contributions
Grandparents can contribute to a grandchild’s pension, providing long-term financial security:
- Pensions can be set up from birth by a parent or guardian.
- Contributions of up to £2,880 per year receive 20% tax relief, increasing the total to £3,600.
- If invested from birth until age 18 and left to grow, these contributions can become a substantial retirement fund.
Tip: Contributions to an adult child’s pension also count as if the child made them, which can affect eligibility for benefits like the High Income Child Benefit Charge or Tax-Free Childcare.
3. Junior ISAs
Grandparents can pay into a Junior ISA (JISA) for their grandchild, provided the account has already been opened by the parent or legal guardian. Junior ISAs allow children under 18 to build tax-efficient savings:
- Investment limit: £9,000 per year
- Management: By parent or guardian until age 16 (child gains control at 16; withdrawals at 18)
- Junior ISAs convert automatically into adult ISAs at 18.
Tip: Make sure contributions are made before 6 April each year, as ISA allowances do not carry over.
4. Child Trust Funds (CTFs)
Children born between 1 September 2002 and 2 January 2011 may have a CTF:
- Government initially deposited at least £250
- Average matured CTF value: £2,240
- Owners can withdraw or reinvest at age 18
Grandparents can initiate the search process if they have the necessary details, although the search is designed for parents or the account holder (if 16+).
Check for “forgotten” CTFs on gov.uk, as hundreds of thousands remain unclaimed. The government estimates that 758,000 matured CTFs have not been claimed by their owners. Many have simply forgotten that a CTF was opened for them.
Tip: Searching ‘find my Child Trust Fund’ on gov.uk will start the process of tracking down any lost account.
5. Lifetime ISAs (LISAs)
Parents or grandparents may want to consider gifting funds to adult children to invest in a Lifetime ISA (LISA). LISAs can currently be used to buy a first home, or save for later life:
- Adult children (18–40) can benefit from contributions to a LISA
- Maximum contribution: £4,000 per year/li>
- Government adds a 25% bonus, up to £1,000/li>
- Can be used to buy a first home or save for retirement
A new first-time buyer product may replace or supplement LISAs, but current rules allow ongoing contributions.
We can help
Passing wealth to grandchildren can be highly tax-efficient with careful planning, but the rules are complex and can change over time. Our team of experienced tax advisors can guide you through your options and help you choose the most effective options for your family. Contact us today to discuss how we can help.
Discover more tax planning ideas
Download our full Year End Tax Planning Guide to explore these options and other tax planning opportunities you could take advantage of before 5 April.
Ammad provides personal taxation planning, advisory and compliance services.
