Jenny Lowe assesses whether government rule changes allowing Child Trust Funds to be converted into individual savings accounts will have an impact.

What a difference five years make – back in 2005 interest rates were on the rise and the UK savings ratio was heading for its lowest point in nearly half a century. Fast forward to 2010 and the trends have reversed, with one savings scheme in particular leading the march and engaging the UK population: the Child Trust Fund (CTF).

Five years on from the first vouchers being issued, the introduction of the CTF has revolutionised long-term savings for children. 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 (£500 for low-income families), from the government.
Further vouchers for the same amount are sent to parents when their children reach the age of seven. In addition, family members and friends can chip in up to £1,200 a year to this tax-free fund.

The vouchers must be invested within 12 months of receipt, otherwise they are invested automatically by HM Revenue & Customs in a stakeholder CTF. It is up to parents to choose between three types of CTF: stakeholder accounts, cash savings accounts and share accounts.

Holding the CTF in cash may preserve capital, but it is likely to be the worst option in terms of preserving purchasing power. Eighteen years is a long time and, while it may go against instinct, parents can afford to take investment risk.
Stakeholder products have an expense cap of 1.5 per cent and are equity based, so are usually low-cost managed funds or trackers. Parents have a choice of around 40 providers. When the child is 13, the funds are moved to lower-risk funds, although these will still be equity based.

Non-stakeholder products represent just 5 per cent of the market, but offer greater investment choice. This is ideal for those who want investment freedom, but because the choice of funds available is considerably wider, it is essential that parents do vast research into which of the funds (or self-select arrangements) is best suited to their needs, as well as how total charges will work out.

These funds also have to be lifestyled, so that they gradually switch into less risky investments after the child hits the age of 13, and charges are capped. This provides parents with an opportunity to take advantage of the potential growth of shares, with the comfort of certain limitations.

A survey from The Children’s Mutual reveals that nearly three-quarters of parents choose to proactively open their child’s CTF account. It estimates that 1.4 million parents, family and friends are contributing to their children’s accounts – with in excess of £22 million being added every month.

David White, chief executive of the Children’s Mutual, says, ‘To those of us involved with the CTF, five years has gone by in the blink of an eye. And yet, in that short amount of time, the results have been startling. The CTF has done what no other savings account has achieved before – it has got the mass UK population engaged and saving.
‘Parents have engaged with the first universal savings scheme, realising that the only realistic way to fund their children’s futures is to start saving now.’

The worry for many parents when it comes to putting money away in a CTF is that when the child reaches 18, they gain control of the fund and can, should they wish, blow it all on a sports car or in the pub having the time of their life.

Trust in ISAs
Some argue that the right education will ensure that 18-year-olds are ready to handle the kind of sums that can be produced by funds. They also note that the government’s decision allowing CTFs to roll into individual savings accounts (ISAs), may go some way to encouraging teenagers to think twice before withdrawing the lot and spending it in one go.

Family Investments’ own research into tax-efficient products has revealed that almost a third of UK adults are unaware of the tax status of ISAs, and 40 per cent believe that CTFs are taxed.

John Reeve, chief executive of Family Investments, says, ‘Given that CTF accounts can now be converted into ISAs once a child reaches 18, those children with CTFs are the first generation of people in the UK that are able to save tax-efficiently for life.

‘We are committed to expanding our offering to make life-long tax-efficient saving easier for families, and ISAs are an important component in this.’

Despite the huge interest in Child Trust Funds from parents, family and friends, there is trouble brewing on the horizon. There has been talk by the Conservative Party of limiting the availability of CTFs to just those children from low-income backgrounds. Under Tory plans, CTFs will disappear for all families earning over £16,040 a year.

‘The CTF is clearly creating a culture whereby parents save more for their children,’ insists Reeve. ‘It has encouraged those who can save but have not previously done so to start saving. Without the nudge to action created by the CTF there is a danger that these positive trends will be reversed.’

Reeve believes that there is also a danger that those who still receive CTFs will be less inclined to make additional savings if any new Conservative government is not committed to ensuring they engage with the scheme.

So what are the other options for those who want to continue to set aside money for their children’s future without paying tax?

Alternative options
The Conservatives recently suggested that parents could put their children’s savings into ISAs instead of a CTF. There are some great ISAs on the market, but a child cannot open an ISA until they are 16, so you must invest on their behalf.

This will obviously eat into your annual ISA tax-free allowance, which is £7,200 for this tax year and rises to £10,200 after April 2010 (this has already increased to £10,200 for the over-50s).

Children have a tax threshold in the same way that adults do and so it is possible to save tax-free for them as long as their income is below the personal allowance of £6,475.

However, they cannot open an ISA until they are 16, at which point they can open a cash product and hold up to £3,600 (£5,100 from 6 April).

Young people under 18 cannot hold investments in an ISA themselves, but parents can use some of their allowance to invest on their child’s behalf.

There are, however, special tax rules in these circumstances. Parents can be taxed on income from a child’s account but only when gifts from a parent produce more than £100 gross taxable income a year.

If that is the case, the whole of the income from the gifts is normally taxed as that parent’s income. A child cannot get back any tax on that income. The £100 rule applies separately to each parent.