When investing for children there are numerous products that could come into
play. These could include bank accounts, National Savings & Investments,
Child Trust Funds, unit trusts, individual savings accounts (Isas) and
stakeholder pensions.
There are many choices to make, including whether to invest a lump sum or
regular premium, the time scale, risk profile and tax considerations.
Bank accounts
There are a number of accounts designed for children, and because these will
often be held for a relatively long time they often offer an attractive
interest rate. Cash deposits are very low risk and would be suitable for
people who are extremely risk-averse or who are not concerned about
inflation.
Geoff Penrice, of Bates Investment Services, the independent financial
adviser, says: "From a tax point of view, if the interest accruing in a
tax year is less than the child’s personal allowance of £6,475, there should
be no tax due. By completing an R85 form, available from the Revenue, the
interest will be received gross."
Care should be taken if the money is a gift from the child’s parents. In this
situation, any interest above £100 will be taxable for the parents.
If each parent makes a separate gift, they can each use their £100 allowance,
thereby allowing interest of £200 to be free of tax. Because of this, if a
significant gift is to be made, it will often come from the grandparents or
other relative as the £100 rule would not apply.
Halifax is currently offering a fixed rate of 6 per cent for one year on its
Children's Regular Saver account, for monthly investments of between £10 and
£100.
The National Savings & Investments Child Bond Issue 33
You can invest between £25 and £3,000 tax-free for children under the age of
16.
The interest is fixed for five years, with the bond currently paying 2.3 per
cent.
This is a very low risk as well as being tax free.
Child Trust Fund
Every child born after September 1, 2002, and receiving child benefit is
eligible.
The Child Trust Fund account is a savings and investment account for children.
The account will belong to the child and cannot be touched until he or she
is 18. Money cannot be taken out of the Child
Trust Fund account once it has been put in.
The child will be able to start making decisions about how the money is
managed when he or she is 6. Neither you nor your child will pay tax on
income or gains in the account (provided that you are UK residents) and a
maximum of £1,200 a year can be saved in the account by you, family or
friends. Each contribution year starts on the child’s birthday and ends the
day before his or her next birthday.
The parents will receive a £250 or £500 voucher to start an account and the
Government will make a further contribution when the child is seven. This
top-up payment will be £250, or £500 for children in lower-income families.
These payments will be paid direct into the child's account. The Government
will contribute £100 every year to the CTF accounts of all disabled
children, with severely disabled children receiving £200 a year. The further
payment recognises that disabled children are likely to have greater
financial needs when they make the transition to adulthood.
There are two types of account: stakeholder
and non-stakeholder. Broadly speaking, the stakeholder option caps the
annual charges at 1.5 per cent of the account's value but imposes certain
investment restrictions. The non-stakeholder is more flexible but can levy
higher charges.
Mr Penrice says: "The Child Trust Fund is an ideal way to save for
children because it offers a bonus payment from the Government and tax-free
returns. It also provides a wide range of investment options."
The only downside is the limitation on the amount that can be invested.
Unit trusts and Open-ended investment companies (Oeics)
These are collective investments that pool investors' money to allow a wider
investment spread: in stocks and shares, bonds or other investments.
Economies of scale mean that the cost of running a collective investment may
be less than that for an individual portfolio.
In general, shares should outperform cash deposits and inflation over the
medium to long term.
Mr Penrice says: "If we consider an investment for a child at birth to
his or her 18th birthday in May 2008, the average balanced managed fund
would have given a return of 273 per cent, against a 68 per cent increase in
the retail prices index and 44 per cent on cash deposits (Halifax Liquid
Gold account)."
Investment trusts perform a similar function to unit trusts and some, such as
Witan, have special savings schemes for children.
But Mr Penrice adds: "If the investment is for a short period, a
lower-risk deposit-based investment would probably be more suitable."
Children have their own tax allowances, the same as adults. It is possible,
therefore, to use the child’s income tax allowance (currently £6,475) and
capital gains tax allowance (£10,100).
Bare trusts
Because children are not allowed to hold investments, they are often wrapped
in a trust. The simplest form of trust is a bare
trust, with the investment held by an adult, usually a parent or
grandparent, on behalf of the child.
However, apart from being the named holder (nominee), the parent has no
beneficial right to the investment and must exercise control for the benefit
of or on the instruction of the child.
The income arising on the investment is taxed as part of the child’s taxable
income and any capital gains as part of the child’s capital gains.
From a practical point of view the bare trust is extremely easy to administer
because there is no trust document. The investment is made in the parent's
name and t+he existence of the trust is denoted by having the child’s
initials in brackets. There is no additional cost in placing the investment
in a bare trust.
Isas
Isas
have proved to be very popular because of the tax benefits.
Cash and corporate bonds held within an Isa are tax-free. Dividends from
shares within an Isa will have 10 per cent tax deducted, but there is no
liability to higher-rate income tax and any capital gains are free from
capital gains tax.
Isas cannot be owned by children. However, many parents invest in Isas in
their own names but earmark the investment for their children. The children
obviously have no right to the investment, and parents have no obligation to
pass on the investment. This flexibility may be useful as it does not tie in
the parents, unlike unit trusts in a bare trust.
Mr Penrice says that funds to consider include M&G Recovery and Invesco
Perpetual Income, both of which have consistently outperformed the index. He
adds that if you want to be a little more adventurous and you believe that
demand for resources will continue, you could consider the Black Rock Gold &
General or the JPM Natural Resources funds.
Stakeholder pensions
Stakeholder
pensions were introduced by the Government as a flexible, low-cost,
tax-efficient way of providing income in retirement. They also allowed for
contributions of up to £3,600 a year to be made on behalf of someone else,
including children. As the contributions attract tax relief at the basic
rate, an investment of £3,600 would cost only £2,880.
This facility therefore allows for parents and grandparents to start a pension
very early in a child’s life. Even modest contributions can grow to a
meaningful sum over a 50-year period. Contributions of £3,600 paid for the
first 18 years of a child's life, and then stopped, would generate a fund of
£1,310,000 at age 60, assuming average fund growth of 7 per cent a year,
with an annual fund charge of 1 per cent.
Although these figures seem large, savers need to offset the effect of
inflation. If we assume inflation of 3 per cent over a 60-year period, the
real value of the fund falls to about £222,350. With an annuity rate of 6
per cent, this would provide an income of about £13,350 in today's terms.
So it won’t solve the child’s pension problem, but it is certainly a step in
the right direction.
Stakeholder pensions can therefore offer a useful way of boosting a child’s
pension. The only downside is that the child cannot touch the money until he
or she is 55.
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