Guide to Children’s Savings

Introduction

It is a striking fact, that while many of us are unwilling to save on our own behalf, we are often prepared to do so on behalf of our children.

Surveys show that while most “normal” investors save for a few years and then give up when other priorities come along, parents saving for children are much more likely to take a long-term approach.

Indeed, one company offering kids’ savings plans, says upwards of 80 per cent of parents keep paying into its schemes 15 or even 20 years after initially setting them up.

Perhaps we should not be too surprised by this: as more and more kids go into higher education rather than leave school and start working straight away, the need to build up a sizeable pot of money to pay for them through their college years becomes even more compelling.

Who does the saving?

One question to consider is whether it is the child or the adult(s) who are doing the saving.

Children may well have different priorities in relation saving, both in terms of access to money, the risk they should be taking for themselves and also the fringe benefits they may need if they are to be encouraged to learn the savings habit.

This will be discussed later. First, let’s focus on the parents.

What can you scrape together?

Many parents are permanently cash-strapped and setting money aside often means making significant sacrifices elsewhere.

If you find yourself in that position, here are some tips that may help:

• Set aside the many small and larger contributions often received when a child is born, placing them in a separate account

• Persuade relatives (and friends, sometimes) to contribute small amounts, maybe as little as £5 every few months, into a savings scheme or account

• Try to do without some or all of your Child Benefits and save that

The Child Trust Fund

Since 2005, the government has offered help to parents with young children through its Child Trust Fund (CTF) initiative.

A CTF is essentially a tax-free fund into which the government contributes £250 shortly after birth, or £500 if a child's parents are entitled to full Child Tax Credit allowance.

An additional £250 payment will be made at age seven and the government is currently consulting over plans for a third payment during a child’s teenage years. The money, which comes in the form of a voucher, can be used to open either a savings account or a so-called “stakeholder” scheme investing in the stock market.

Parents – or relatives and even friends – can then save up to £1,200 a year extra, free of tax, until a child reaches 18. The money will then be available for any purpose, or can be rolled over into another tax-free ISA. See our Guide to ISAs.

For more details of Child Trust Funds, click here

What about tax?

Children have the same personal tax allowances as adults. In the 2008-2009 tax year, these are £6,035 before tax needs to be paid on earnings.

At current rates of interest, a child would need to have between £80,000 and £100,000 saved up in an account to pay any tax.

If you go to open a savings account in a child’s name, take in his or her birth certificate, fill in form R85 (available from the bank or building society) and return it to HM Revenue & Customs to get interest paid gross.

Be careful about how you pay money in: if you pay money into your child’s account, you may have to pay tax if the interest on the gift exceeds £100 per parent (note: two parents equals £200 of interest annually, so divide up the way money is paid into an account if necessary).

Bizarrely, relations can save as much as they like in a child’s account – any income it will simply be counted as part of his or her tax allowance.

At age 16, children can set up their own mini-cash Investment Savings Accounts and place up to £3,600 a year in it, free of income tax. But they can’t open an equity ISA until they reach 18. See our [LINK]Guide to ISAs.

There are also various other tax-free savings schemes, such as National Savings and other accounts, of which more below.

How to invest

If your child is young and you are planning on saving at least until his or her university age, it makes sense to place the majority of your savings into share-based products.

Although shares are relatively volatile investments, over a 15- or 20-year time horizon they tend to outperform cash savings accounts.

Even so, a few years before the money is needed, make sure you transfer back a proportion of your funds into less risky products, to safeguard what has been built up already.

If you are saving in an ISA, don't keep all your eggs in one basket. Invest in a new provider or a new fund every year to reduce investment risk. Note that this is not possible with a Child Trust Fund-style investment.

Also, make sure that a proportion of funds remains in a low-risk environment, so that there is always some protection against risk. And keep some money available for emergencies, or even for school trips.

Savings products

There are many different schemes you can use to save, ranging from risk-free to very volatile. Choosing between them is a personal decision, based on your attitude to risk.
Here are some of the options available:

• Bank and building society savings accounts. There are more than 100 available for children, most offering a combination of decent interest rates plus various additional benefits aimed at engaging with your child

The account may be in your child’s name and he or she can deposit money – and in some cases take it out. If the child is under 7, the parent will have to open the account in an adult's name.

• National Savings & Investments: this state-backed savings bank offers a range of schemes, including five-year Children’s Bonus Bonds, which pay a guaranteed rate, free of tax, plus a bonus

You can invest up to £3,000 in each issue per child, with issues being launched each year on average, or when interest rates change. At the fifth anniversary, you can roll over the bond or cash it in

The bond is owned by the child, but controlled by the parents until age 16. Bonds can be cashed in without notice. Bonds can be held until a child reaches 21, with the last date for investment being just before a child reaches 16.

• Friendly society savings schemes: these are mutually-owned organisations with a history stretching back hundreds of years in some cases. They are allowed to offer long-term tax-free savings schemes or bonds, up to a maximum contribution limit of £25 a month or £270 a year. The money usually goes into “with-profits” funds, which invest in a combination of shares, bonds and property

Saving in these schemes can be a good idea if you are prepared to sit out an investment. But they can have high charges and heavy penalties if the product is surrendered early. So you should bear this in mind before you start.

• Unit and investment trusts and ISAs: here, the choice is virtually limitless. There are upwards of 2,000 funds to choose from

Children are unable to invest in a unit and investment trusts or tax-free ISAs until they reach 18, so while a fund may be designated with a child’s initials, it will still remain in the child's name. When the child reaches 18, an ISA cannot simply be transferred into their name, sadly.

Kids doing it for themselves

What if children want to save on their own behalf?

Here are some things to look for:

1) The interest rate paid. That said, while always important, it may not be THE most significant aspect. This is because unlike adults, children have less access to the internet or phone. Also, the amount they are likely to save is unlikely to benefit from that extra 0.5 or even 1 per cent per cent from the best account.

2) Access to the account (local branch or post), without penalty. It has to be local, within walking or bus-catching distance.

3) Incentives to save. This can range from free magazines and piggy-banks to videos and CDs, club membership and even signed pictures of the local football team’s top striker. You have to accept that this may well be the dominant influence in a child's decision to open an account with a provider.

If so, it becomes an issue only if you are combining what you save on their behalf with what they save for themselves. In this respect, it may make sense to keep two separate sets of funds/accounts, a long-term one into which the bulk of the money is paid, the other as the one that is controlled by the child.

In some cases, a percentage deal may work, or whatever the child saves is topped up by parental contributions. This is up for negotiation.

Any other wheezes?

Parents can save up to £3,600 a year into a stakeholder pension scheme on behalf of their children. With appropriate tax breaks, this becomes £2,808 after tax relief.

Setting aside the maximum amount for the first five years of a child’s life would build up a pot of more than £295,000 by the age of 55, the first point at which it becomes accessible (under soon-to-be introduced), assuming growth of 6 per cent.

Even taking inflation of 3 per cent into account, it could still deliver a pension of around £7,000 a year at today's annuity rates.