It is very difficult to open a newspaper or switch on the TV without being reminded of the need to put money away for our offspring. The Child Trust Fund scheme (CTF) was introduced by the government in April 2005 as a long-term savings account for children. Under the initiative, children born on or after 1 September 2002 are eligible to receive £250 for their parents to invest on their behalf, or £500 for lower
income families.

According to The Children’s Mutual (TCM), a specialist in long-term savings for children, 2007 was the year in which the face of savings changed for a whole generation. David White, chief executive of The Children’s Mutual, points out, ‘Our figures show that family engagement with the CTF has increased hugely, with more and more families now saving regularly for their children. Every eligible child under five, and many five-year olds, now have a CTF, meaning that the UK is home to the first-ever generation with a universally promising financial future.’

Growing interest
White adds, ‘Before the CTF was introduced, one in five families was saving regularly for their children. This has now leapt dramatically and in 2007 almost half of new CTF accounts placed with us received monthly top-ups from the outset. And families of every social background are saving, meaning the CTF really will help provide a financial springboard into adulthood for the trust fund generation.’

A CTF can be invested in one of three ways, depending on how much risk the parents wish to take – stakeholder and non-stakeholder shares, and non-stakeholder savings.
With the stakeholder option, the fund is exposed to equities and the maximum charge is 1.5 per cent per annum, so the majority of stakeholder offerings are trackers.

According to Anna Bowes, investment manager at AWD Chase de Vere, F&C has the cheapest stakeholder tracker and is worth considering if this is the preferred option.
Bowes adds, ‘While I feel that cash is not the most appropriate investment for the long term, for those who are insistent they want to be as safe as possible, Britannia, Yorkshire Building Society and Shepshed Building Society are offering competitive rates at 7.50 per cent, 7.05 per cent and 6.90 per cent respectively.’

She points out that ‘In terms of non-stakeholder offerings, TCM offers access to some great funds from Invesco Perpetual, Gartmore, Insight and UBS, including the Invesco Perpetual Income Fund and Gartmore Cautious Managed.’

Once the voucher has been invested, parents and relatives can top-up the account to a maximum of £1,200 per year. Ian Bennings, product development manager at The Share Centre, insists,

‘It is very important for parents and relatives to add to the CTF as the actual value of the voucher alone is fairly limited, but a small contribution each month can make a substantial difference. It is something you’re being given for nothing, but to really help your child’s financial future you must put in extra.’

The tax position
Children have their own personal tax allowance, which means that they will not pay tax on the first £5,225 of income and the first £9,200 of capital gains made in the current tax year (2007/08). However, if you, as the parent, decide to open a savings account or invest money on behalf of your child, only the first £100 of interest earned or income received each year is considered as belonging to the child, making it taxable against your earnings. With a CTF, this rule doesn’t apply as the accounts can be topped up to £1,200 per year tax free.

The rules on when you can top-up a CTF are fairly relaxed. While you can set up a regular monthly or annual standing order, ad hoc contributions are also possible, with minimum single contributions ranging from £1 to £500, depending on the account.
The main disadvantage to topping up your child’s CTF is that when they reach 18, they are automatically entitled to the money and you will have no say over how they spend it. However, research by TCM found that when given the proceeds of a savings scheme, children appreciate its value and spend it wisely, rather than fritter it away on
an expensive car or holiday.

The government has created a solution to encourage more parents and relatives to add to the child’s fund. As Ian Bennings points out, ‘As of April 2008, money held in a CTF can be rolled into an ISA when it reaches maturity and can continue to grow tax free.’

Children without CTFs
There are approximately 10 million children in the UK who are too old to qualify for a CTF and too young to invest in an ISA and are therefore denied the opportunity to save a tax-free lump sum. For these children, many parents have opted to use up part of their annual ISA allowance to save for their child’s future.

Sherry-Ann Sweeting, marketing manager at The Scottish Investment Trust Plc, explains, ‘Parents whose children aren’t eligible for a CTF or who wish to invest more than the set annual limit will need to look at other options if they wish to save for their children. There are a number of products built around a variety of asset classes that may be suitable, with the choice of asset complementing the envisaged time scale and use of the savings. Cash deposit accounts are popular and can be ideal for short- to medium-term, instantly or easily accessed savings. Most banks and building societies offer special accounts for children or for adults to open on a child’s behalf.’

The tax benefits of CTFs and ISAs are very similar, but for many parents using ISAs to build a nest egg for their children, the main attraction is that the money is held in the parent’s name, preventing any irresponsible spending on the child’s part.

You can use an ISA to save cash, or to invest in stocks and shares, depending on how much of a risk you want to take. Under the current ISA rules, you can opt for a maxi or mini ISA. A maxi ISA can contain cash, investment-based life insurance or stocks and shares, all of which must be with the same ISA manager, and can hold up to £7,000. A mini ISA can contain stocks and shares, a life insurance policy or other medium- to long-term investments or cash with saving limits of £4,000 and £3,000 respectively.

However, the structure for ISA saving will be significantly simplified by the new rules that are due to come into force this April. There will no longer be a mini/maxi distinction between ISAs. Instead the option will simply be a cash ISA or stocks and shares ISA. There is also the opportunity to save much more as the annual investment limit will rise to £7,200 and up to £3,600 of this can be saved in a cash ISA with the option of investing the remainder in stocks and shares.

Getting the right fit
It is very important when choosing which form of ISA to put your money in that you know what to expect. A cash ISA allows you to put away your money to accrue interest just like it would in an ordinary bank or building society account, but with the advantage if being tax free. On the other hand, a shares ISA invests in the stock market, so although any gains the money makes will not be taxed, the capital will be exposed to the ups and downs associated with stocks.

For most parents, the money being put aside will be left alone for quite a few years and where cash ISAs can be a useful place to put money to gain interest, avoid tax and have easy access at relatively short notice, a shares ISA, like all stock market investments, is considered a long-term investment.

Sweeney points out, ‘Saving for children, with or outside the CTF, should have the same aims as for adults – building a balanced and diversified portfolio of savings and investments across a range of asset classes. The suitability of each being determined
by their fulfilment of short-term or long-term requirements.’