Saving for your children

January 7th, 2006

What are the best ways to put money aside for children? A leading financial adviser outlines some options.
Parents and grandparents often think about setting aside a sum of money, or starting a regular savings plan for young children, so that when the young person is older they have a capital sum to start them off in life.

This might be used, for example, to pay for further education or as a deposit for a first home.

The first savings for a child are usually cash deposits. These can be in accounts specifically set up with banks and building societies for children.

Children’s savings accounts have a maximum age limit for the account holder, which can be high as 21 for some accounts.

There are also accounts available that have a minimum age limit, so they are accessible by 11-16 year-olds, for example.

Because these accounts are designed to start children off in the savings habit, they often pay a higher rate of interest compared to other savings accounts.

Most accounts also offer incentives such as CD tokens and newsletters, and sometimes a birthday card.

Long-term benefits

Many parents choose to save their child benefit. Currently this is paid at a rate of £16.50 per week for the first child.

KEY POINTS
Start saving for children as early as possible - the earliest gifts earn interest for longer
Cash accounts are a good home for smaller gifts, and encourage the savings habit
Stock market funds are ideal for longer-term savings
Look out for low-cost pooled investments such as index tracker funds
Take advantage of tax planning opportunities
Assuming savings at this rate (it usually increases but I have ignored this for this exercise), and taking a long-term gross interest rate of 4.5%, this would amount to almost £24,000 by the time the child reaches age 18.

Obviously this will not have the same buying power as today, but will still be a worthwhile sum.

Parents versus relatives

Interest earned on deposit accounts is subject to income tax. Children, like adults, have a personal income tax allowance (£4,895 for the 2005/2006 tax year).

If the account holds money gifted by friends and relatives - but not parents - any interest earned from the savings account may be set against the allowance.

As long as the total amount of interest falls within the allowance, then no tax will be payable.

Where parents save on behalf of a child, the tax rules are different

When an account is opened, a form R85 should be completed - you can obtain this from the bank branch.

This confirms that the account holder is a non-taxpayer and allows interest to be received without the deduction of income tax.

Where parents save on behalf of a child, the tax rules are different. Only £100 of interest (per parent) can use up the child’s personal income tax allowance.

Where interest exceeds this level, the whole of the interest will be taxed on the parent.

This is really a mechanism to prevent parents from holding their own cash savings in their children’s names and taking advantage of the tax allowances.

Where both parents and other relatives are saving on behalf of a child, consideration should be given to opening separate accounts - one for parents’ gifts and one for gifts from other relatives.

New savings plans

The child trust fund (CTF) encourages saving for children.

The CTF provides a government-funded endowment of a minimum of £250 per child at birth (and up to £500 for those children from lower income families).

When saving smaller regular amounts, the best way to invest in the stock market is through a unit or investment trust

Parents, as well as friends and relatives are able to add to the fund.

The fund will be mature when the child reaches 18 and there will be no restriction on how the proceeds are used.

Riskier investments

There are savings opportunities beyond cash accounts and these should not be ignored.

Over the longer term, stock market funds have outperformed other types of investment, although in the shorter term these can be volatile.

One of the benefits of saving for children is that investment is generally for the longer term - more than 10 years, and very often made on a regular basis.

Both of these factors help to reduce the risks associated with investing in shares.

When saving smaller regular amounts, the best way to invest in the stock market is through a unit or investment trust.

These are pooled investment funds which give access to a wide spread of shares and other securities such as bonds.

These funds may be actively managed - where a fund manager picks individual stocks based on a view of their future potential - or passively, where a manager invests in all the shares that comprise a stock market index, such as the FTSE 100.

Taxing issues

The main objective when investing in the stock market is capital growth.

When investments are sold, any gains are potentially subject to capital gains tax. Everyone is entitled to an annual capital gains tax allowance (£8,500 for tax year 2005/2006).

Unlike income tax, there is no restriction on the use of this allowance, even if parents have made investments for children.

As the time when savings will be needed approaches, these should be moved gradually from stock market investments into a safer home such as a cash account in order to consolidate growth.

This will help to protect savings should a market downturn occur just before the money is needed.

A combination of cash and share investments (as opposed to inflexible investment policies) can meet most savings needs.

These allow flexible savings that can accommodate regular contributions as well as any lump sums that might arise as a result of birthday or Christmas gifts.

There is no obligation to maintain regular payments, which may be stopped and then resumed at any time, without penalty.

The views expressed are solely ours and are for general information only. They do not constitute financial advice as defined by the Financial Services Act and are not intended to be relied on for the purposes of making an investment decision.

Always obtain independent advice from a qualified, registered financial adviser before making any investment decisions.

Entry Filed under: Savings Accounts, Finance Info