Collective Investments for Children Guide
Children have never been more expensive. If you add up the cost of feeding and clothing your offspring, pocket money, school and university fees, their first car, home and wedding, the amount could easily top £150,000 per child.
The cost of raising children
- The average annual private day school fees in 2006 was £8,790, or £20,970 for boarding school fees in 2006 (source: Independent Schools Council, 2007 census);
- the average cost of a wedding in the UK in 2006 was £16,000 (source: Mintel);
- a modest second hand car could cost £5,000 in today's money, and a great deal more when your child reaches age 17 (source:
- the average cost of funding a child at university per year is £10,000 (source Fidelity August 2007, based on NUS and Dfes estimates)
- UK students left university in summer 2007 with an average debt of £13,500 (source: Barclays Bank August 2007).
- the average cost of a first time buyer property in September 2007 was £150,999 (source: Halifax, October 2007)
Benefits of regular saving
Financial advisers always recommend that you start as early as possible because even small amounts can add up to a reasonable nest egg, by the time your child reaches 18.
The longer your investment horizon, the more you can afford to invest in higher risk assets such as equities, property and corporate bonds, whereas if you are investing for only five years, you would normally be advised to save in lower risk assets, such as cash and fixed interest securities.
The benefit of saving regularly in equities, via an investment fund such as a unit trust or Oeic, is that when unit prices are low, you are purchase more units for your money than when unit prices are high, so that when the stock market rises, those units will be worth more. In addition, over the long term, equities tend to outperform cash and deposits.
According to Fidelity, by saving just £50 a month for 18 years from the birth of a child, you could create a pot worth £26,640 (source: Morningstar, based on the FTSE All Share index from 1 August 1989 to 1 August 2007).
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Child Trust Funds
One of the best known forms of saving for children is the Child Trust Fund, or CTF. These were launched as a means of helping parents and relatives invest to provide a nest egg for their offspring at age 18.
Since the beginning of 2005, the parents of all babies born in the UK on or after 1 September 2002 have been eligible to receive Child Trust Fund vouchers, worth £250, from the Government.
Further vouchers for the same amount are sent to parents when their children reach age seven. In addition, family members and friends can chip in up to £1,200 a year to this tax free fund.
But remember that vouchers must be invested within 12 months of receipt. Otherwise, uninvested funds will be invested automatically on your behalf by HMRC in a stakeholder CTF.
If you are on a low income (namely your household income is not more than the Child Tax Credit threshold, of £14,495 for 2007-08), you will receive an extra £250.
But it is up to parents to decide which type of Child Trust Fund account they want to invest in from the following three types of account:
- stakeholder accounts
- cash savings accounts
- share accounts
For more on CTFs, read our Guide to Child Trust Funds at: www.find.co.uk/investments/isas/back_to_basics_guide_to_isas
Individual Savings Accounts (ISAs)
Another popular vehicle for regular saving is the Individual Savings Account or ISA. Although there are no tax breaks on entry, the investments you make roll up largely tax free and on exit, there is no income or capital gains tax to pay.
In the tax year 2007-08, there continue to be two types of ISA: the mini and the maxi. You can't invest in both types during the same tax year - you can either have one maxi ISA or two mini ISAs (one cash and one equity), which can be with two different ISA providers.
A maxi ISA is an account from one ISA provider, split into two components, allowing you to invest up to £3,000 in cash and £4,000 in equities (stocks and shares). Or you can invest the whole £7,000 in the equities component.
With a mini ISA, you have a separate account for each component, and you can buy each element from a different provider, investing £3,000 in cash and £4,000 in equities.
New ISA rules from 6 April 2008
From 6 April 2008, there will be a number of changes to the ISA rules. The confusing distinction between mini and maxi ISAs will be abolished and the maximum you will be able to invest each year will rise to £7,200.
Another change will be that a cash ISA can be converted into an equity ISA, but not vice versa. So if you are not sure where to invest or are wary stock market volatility, you could invest in cash for the time being, and convert the money into an equity ISA after April 2008.
A major advantage of investing via an ISA is that investment funds can often be purchased more cheaply within an ISA wrapper (providing you buy through an independent financial adviser, fund supermarket or a discount broker) than if you bought the same fund from the fund managers directly.
ISA savings are also highly accessible because you can encash all, or part, of your savings at any time without penalty. The same cannot be said for pension savings which are locked away until age 55.
National Savings & Investments
Children's bonus bonds
Other investments you might wish to consider are National Savings products, some of which are tax free.
For instance, the NS&I Children's Bonus Bonds (Issue 24), pays a fixed rate of 5.1 per cent pa over five years, tax free on maturity. Included in this rate, is a bonus contingent on you holding the bond for the full five years, otherwise, you will not receive the full 5.1 per cent.
Premium bonds pay two, tax-free cash prizes of £1m or over, each month. You can invest from £100-£30,000, on behalf of a child under 16, providing you are the parent, guardian, grandparent, or great grandparent of the child.
Index linked savings certificates
The returns are exceed inflation, when held for at least one year. You can invest from £100 up to £15,000 tax-free in each issue. Both the 15th issue of 3 year certificates and the 42nd issue of 5 year certificates were paying the RPI+ 1.35 per cent compound at the time of writing.
Other NS&I products you may wish to look at include its fixed interest savings certificates, capital bonds and income bonds.
Stakeholder pensions for children and grandchildren
Few investments can beat contributing to a stakeholder pension for a child or grandchild. Although your child will not be able to draw on the pension until age 55 (under current pension rules), many young people cannot afford to make pension contributions until their 30s, even 40s, because of the need to service student debt and mortgages.
There no tax implications for either the donor or the beneficiary and by investing for the first 18 years of your child's life, you will be giving them a flying start in the retirement savings stakes.
By the time your child reaches age 18, he or she can either start making contributions themselves, or, if this is not possible, simply leave the fund to roll up, largely tax free until they reach age 55.
Many parents and grandparents are still unaware that, since the introduction of stakeholder pensions in April 2001, they can pay into a pension for a child/grandchild. In fact, anyone including godparents and friends can make stakeholder pension contributions on behalf of a child.
Investment rules for children's stakeholder pensions
The rule is one stakeholder plan per child. So a group of relatives such as parents, grandparents, godparents and other relatives can contribute in total £2,808 (£3,600 gross) to a child's stakeholder. The application form has to be signed by a legal guardian or parent, but the direct debit can come from any individual.
Contributions to all personal pensions are paid net of standard rate tax at 22pc, even if the child is a non taxpayer, so that the maximum net contribution is effectively only £2,808.
HMRC adds an extra £792 in the form of tax relief, making the total annual contribution £3,600. The £2,808 can be paid as a single lump sum or as regular monthly contributions.
But there is no higher rate tax relief, unless the child happens to be a higher rate taxpayer, which is highly unlikely. This means that even if you, as the parent, godparent or grandparent, are a higher rate taxpayer, you cannot claim higher rate tax relief because the latter is based on the child's tax status, not yours.
What your investment could grow to
Legal & General estimates that a single net lump sum contribution of £2,808 for a three year old would grow to an estimated fund of £24,721 by the time the child reaches age 60. This could provide a male grandchild with an income of £1,432 pa (based on 7pc pa investment growth, 2.5pc inflation and a 4.1pc annuity rate for a male, single life at age 60).
A female grandchild would receive slightly less because women live longer than men, (although the difference in life expectancy between the sexes is narrowing rapidly).
For maximum effect, it is best to start contributions as early as possible. L&G calculates that parents/grandparents, who invest £2,808 net a year for a child from birth until age 18, could create a pension fund of £327,000 by the time the child reaches age 65 (assuming a growth rate of 7 pc a year, 2.5pc inflation and total annual management charges of 1.5pc).
By contrast, a child who starts to save for a pension at age 30, making the same contributions, would build up a fund, based on the same assumptions, of just £127,000 by age 65.
Adrian Boulding, L &G pensions strategy director, says: "It's a smashing opportunity. By setting up a pension for a child or grandchild at birth, the fund will have 55 years in which to grow, so even small contributions could produce a decent size fund. By the time your child reaches age 18, or as soon as it can afford to, he or she should be encouraged to make their own contributions."
Visit our annuity calculator to see how much pension your child's fund could buy at retirement: http://www.find.co.uk/pensions/annuities_centre/annuities-calculator
A stakeholder pension rolls up largely free of income tax and completely free of capital gains tax. There is an ACT deduction before dividends are paid which, since 1998, cannot be reclaimed by the pension fund.
How a stakeholder pension can be taken
Under current rules, the pension can be taken at any time from age 55 and up to 25pc of the fund can be taken as tax free cash and the remainder used to purchase an annuity.
Alternatively, your child could leave the rest of the fund invested in the stockmarket and take an income from the fund, when required. This is called doing income drawdown, or taking an 'unsecured pension.' This can be done until age 75, when most people, under current pension rules, are required to purchase an annuity.
Pension rules are liable to change. However, pension saving is currently a highly tax effective form of investment which is worth considering providing you can afford to make the contributions. It is usually advisable to pay off debts before saving.
Can't afford to save?
Anyone who says they can't afford to save £50 a month should bear in mind that £50 a month is probably less than what they spend on their monthly mobile phone bill, gym membership or a meal out for four.
Alternatively, you could use your child benefit to invest in a CTF, ISA or stakeholder pension for your offspring.
Child benefit (£18.10 a week for the eldest child, £12.10 for other children in 2007-08) amounts to £941.20 a year for the first child and £629.20 a year for a second child, or a total of £1,570.40 a year. By topping this up with £930 of your own money, you could invest around £2,500 a year on behalf of two children.
Tax treatment of investments made on behalf of children
Income deriving from investments made by parents of up to £100 is tax free, but any such income in excess of £100 is taxable on the parents. This is why it is a good idea to take advantage of tax free investments such as ISAs, CTFs, stakeholder pensions and those NS&I products which are tax free.
However, income deriving from investments made by grandparents, is taxable as if it belonged to the child, which means that a child can offset this income against their own personal tax allowance of £5,225, and capital gains against their CGT tax allowance of £9,200 (tax year 2007-08).
Friendly society bonds
Friendly society bonds are investment funds held within a life assurance wrapper, whose returns are tax free at maturity. They are often invested in with profit funds, whereby annual bonuses awarded over the life of the policy cannot be taken away, and peaks and troughs of equity investment are supposed to be smoothed out through a bonus system.
However, with profit funds have become less popular in recent years because of poor performance by some funds during the bear market of 2000-03 and hefty market value adjusters for investors wishing to cash in early. Policies are usually set up for 10 years, with maximum contributions are £25 a month or £270 a year.
For more on Investments for Children, read our Guide at: www.find.co.uk/investments/funds&trusts/guide-to-investments-for-children
Last edited October 2007