Money tip #79 – How to save and invest for your child’s future (part 1)

How to save and invest for children

If like me you’ve got a new bundle of joy to look after it won’t be long before your thoughts turn to how best to provide for your child’s future.

But knowing how best to save or invest for your child can be a bit of a minefield. So we’ve decided to cut through the jargon and set out what parents’ options are.

Open a children’s savings account – Most banks and building societies offer some form of savings account for children and they operate in much the same way as adult accounts. Having said that, before the age of 7 accounts have to be held in the parent’s name (although earmarked for the child). Children have the same annual personal income tax allowance (£6,475 for tax year 2010-11) which means any income/interest earned up to this level is tax-free. Usually bank interest is paid net of 20% tax so parents need to ask for an R85 form when they open the account to ensure gorgeous little Oliver gets his interest tax-free.

The current best savings rates can be found here…

But a couple of things to be aware of:

1)       Gimmicks – lots of accounts will fob you off with naff toys etc to disguise the poor interest rate on the account. Don’t be fooled.

2)       If you're a parent or step-parent and the money you give your child earns more than £100 interest a year, this interest will be taxed as if it were your own. However, 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.

Pros:

• Low risk
• Easy to administer and top-up
• Tax efficient - up to £100 interest per tax year (per parent)

Cons

• Child will gain access at age 7 – but you could always hide the passbook
• Interest rate may not keep pace with inflation – so reducing the real value of your investment

Child Trust Funds – if your child was born after 1^st September 2002 and is eligible for child benefit you’ll get a £250 voucher to invest in a Child Trust Fund (CTF) – although this will be changing as a result of the Emergency Budget. (UPDATE  24/02/11 - The government has stopped issuing Child Trust Fund vouchers for children born after 2 January 2011). The Child Trust Fund (CTF) is a long-term savings and investment account and the money cannot be withdrawn until the child is 18 – unless they are terminally ill. All interest/gains are tax free and you can invest up to £1,200 a year into it, via cash or investment funds. More info can be found here.

Pros:

• Tax-free
• Free contribution from the Government
• Child can not gain access until they are 18
• Gives some access to investment options other than cash

Cons

• Soon to be withdrawn by the Government
• Limited investment amount each year
• Limited investment options
• Interest rate on cash holdings may not keep pace with inflation – so reducing the real value of your investment

Junior ISAs - The government has unveiled a replacement for Child Trust Funds which will be called Junior Individual Savings Accounts (JISAs). These effectively supersede Child Trust Funds and will be available from 1st November 2011. For full details see my post Junior ISAs explained.

Pros:

• Tax-free
• Child can not gain access until they are 18
• Gives some access to investment options other than cash
• Can invest up to £3,000 per tax year

Cons

• Limited investment amount each year
• Limited investment options
• Interest rate on cash holdings may not keep pace with inflation – so reducing the real value of your investment

Children's Bonus Bonds from National Savings and Investments (NS&I) - NS&I Children's Bonus Bonds are offered by National Savings & Investments and because they are backed by the Government and are a safe way of saving. They provide tax-free interest to children under 16 and you can invest between £25 and £3,000 per issue, of which there are several a year. The Bonus part refers to the bonus that is applied if the investment is left untouched for 5 years. You can invest online or via the Post Office.

Pros :

• Tax free
• Controlled for the child until they reach 16
• Secure savings vehicle as backed by Government

Cons

• A limit on the amount that can be invested.
• Interest rate may not keep pace with inflation – so reducing the real value of your investment
• Child takes control at age 16, despite the fact they can be set up to be held until the child is age 21.

Index-linked Savings Certificates (NS&I) – (UPDATE 24/02/11 Index-Linked Savings Certificates have since been pulled due to demand). Although these investments were not specifically designed with children in mind they are, nonetheless, a useful investment vehicle, particularly as the value of the investment is guaranteed to keep up with inflation and returns are tax free. You can invest from £100 to £15,000 for three or five years in Index-linked Savings Certificates. Given that the rate of inflation used is RPI which is around 5% currently this is a particularly attractive investment for high rate tax payers. See our previous post Money tip #30 – One way to protect your savings from inflation, both tax and risk free.  Children under seven need someone else to purchase the certificates on their behalf.

Pros :

• Tax free
• Controlled for the child until they reach 16
• Secure investment as backed by Government
• Will guarantee to provide a return in excess of inflation.

Cons

• A limit on the amount that can be invested
• Child takes control at age 16

Remember to check back tomorrow for the second part of our guide on how to invest and save for children.