In the past couple of years, parents and grandparents have had a real chance of providing their children with a financial boost when they reach the age of 18, all courtesy of the government and its Child Trust Fund (CTF) initiative. This innovation has the potential to achieve an income tax- and capital gains tax-free investment pot of over £50,000, with some additional funding and the right investment selection.

Basic details
Under the CTF scheme, every child born after 1 September 2002 receives a voucher worth £250 for their parents to invest on their behalf. In addition, parents in receipt of child benefit and with a child qualifying under the scheme also now receive additional lump sums of up to £750, depending on the income in the household. Then at the age of seven each child gets another £250 voucher – or £500 in lower-income households (i.e. currently with an annual gross income of £14,155 or less).

Parents have a year to invest their voucher by opening a CTF account – that is the only way the investment can be realised. If they don’t, the government will automatically open an account for the child.

There are three CTF account options. There is a savings account, where the voucher amount, and any other monies added by the parents, are invested in cash. Then there is the stakeholder account and non-stakeholder accounts, both of which are invested in shares.

CTF stakeholder accounts must meet set government criteria. A minimum investment must be allowed of £10 per month. There must be no initial charge, other charges must be capped at 1.5 per cent a year and the CTF can only invest in broadly based funds to help spread risk. In addition, a process called ‘life-styling’ acts as a form of risk reduction, so that when the child gets to the age of 13, exposure to the riskier shares option is reduced. By the end of the investment term (when the child is 18) the investments are in low-risk investments or cash.

In addition to the initial voucher amounts, parents can invest up to £1,200 each year. The investments are income tax and capital gains tax free. While it may be the parents who are investing on the child’s behalf, it is only the child who has access to the funds and then only when they turn 18.

A popular move
CTFs have suffered much knocking from mainstream investment commentators, but David White, chief executive of The Children’s Mutual, says the public at large are embracing the CTFs.

‘From the outset, we were aware that, if only because parents weren’t getting any sleep, they might not get around to doing anything with the voucher, which expires after a year, at which time the government will open the account. But 75 per cent of accounts are being opened by parents. If you compare that with the take-up of occupational pensions, which is about 51 per cent, that is a remarkable figure.’

He adds that over the past two years 50 per cent of the parents opening an account with The Children’s Mutual are also starting a direct debit at the same time, putting in £24 per month on average.

‘About nine per cent of accounts have ad hoc payments of about £400 a time put in. If parents save £24 from birth, and the government money is going in as well, you are looking at £9,800 at age 18. If we get half the children arriving at 18 with the best part of £10,000 we are talking about a different world for them,’ says White.

He adds that parents are realising that youngsters in their 20s face a stiff financial challenge: ‘Those with children aged 18 to 30 have often had to remortgage the house or raid the savings to help their children out. The blunt message to parents is that you will face this problem. You will probably want to help your young adult children to buy a house and get on their way.’

He adds, ‘You will find the pain is easier if you can embrace a CTF and save what you can afford when they are young instead of trying to find tens of thousands when they are in their 20s.’

Deciding on the stakeholder
You will potentially get more from your investment with stakeholder and non-stakeholder CTFs investing in investment funds.

The majority of CTFs (70 per cent) are stakeholder ones and around 22 per cent are cash CTFs, according to HM Revenue and Customs (HMRC) statistics. This suggests parents are missing a trick, according to Jason Hollands, head of communications and strategy at F&C Investments: ‘The true stock market option is a relatively modest part of the CTF market. The money put into stakeholder CTFs is, in large part, because they are perceived to have this government “Kitemark” of value for money because of the charging cap. Actually you can get an infinitely better deal on charges by investing in something like the Foreign & Colonial Investment Trust.’

Hollands says that if you look at the 70 per cent of the market in stakeholder products nearly all of the providers are charging the maximum 1.5 per cent and the lion’s share of these tend to be index trackers.

‘1.5 per cent is quite a high fee for an index tracker and for locking in that level of underperformance,’ he continues. ‘But if you take a large investment trust, the total expense ratio is 0.5 per cent. In other words, parents think they are getting value for money when, in fact, they are investing in index trackers. They are probably wholly invested in UK equities whereas they could get a diversified global portfolio, which includes private equity, Asia, emerging markets and UK equities. This has actually done better than the market.’

Accounting for risk
Getting the best from your investment into CTFs very much depends on your attitude to risk. Investment in a cash savings scheme will, more than likely, generate less than if your investment is in stocks and shares.

The CTF calculator, available at www.childtrustfund.gov.uk, allows you to see just what your investment could receive depending on the type of CTF you opt for and how much you additionally invest.

For example, putting £250 into a savings CTF today, plus the additional £250 at the age of seven, will generate a return of £830 at the age of 18, assuming a 3.5 per cent interest rate.

However, the same amount invested into a shares-based scheme would, assuming an interest rate of five per cent, generate £1,020. If the assumed rate of return is seven per cent, the return would be £1,360 and, assuming nine per cent, £1,800. The same interest rates applied under a stakeholder scheme would respectively produce £980, £1,230 or £1,540.

Of course, investors are warned that there is no guarantee on these figures, and that the amount invested today may not buy you as much in the future. Also, these figures do not include the management charges you will pay on shares accounts, which can be more than 1.5 per cent per annum for a non-stakeholder product (on a stakeholder account, charges cannot be more than 1.5 per cent per annum).

When you add some additional savings, the picture is different again. Adding £100 a month into a cash savings-based scheme, again assuming an interest rate of
3.5 per cent, could net you £30,220 from your £21,600 investment (i.e. £1,200 per annum for 18 years). Interestingly, opting to lump-sum invest £1,200 per annum, according to the CTF calculator, the final return would be £29,030.

Regular saving is, however, often a more practical solution. Again, committing to £100 per month into a shares fund could generate £34,970 assuming five per cent growth, £42,680 assuming seven per cent or £52,340 assuming nine per cent. Under a stakeholder, the calculator gives out respective returns of £33,590, £38,850 or £45,150. Investors should note that when calculating these figures, the government’s website does warn that assumptions are applied about the rate at which shares are changed to less volatile investments from the child’s age of 13 to 18.

CTFs in action
Claire Wagstaff is a parent who opened a stakeholder CTF with her daughter Ava’s £250 voucher and opted to pay £20 per month regularly into the fund.

She argues that ‘It makes sense to utilise the government voucher and we chose The Children’s Mutual’s product. As we also wanted to have some form of savings account for her, it made sense to add money that would be locked away for her until she is 18.’
She adds, ‘We know the market can go up and down but with the life-styling process, whereby at 13 the investments go to a less risky investment, it seemed a more balanced option for us. We have a separate savings account we can access if we want to and we were prepared to take more of a risk with that one. So we have the balance of flexibility and risk all round.’

Hollands says regular CTF saving is a great discipline: ‘CTFs prompt people to think about putting some money aside for the children, which is very sensible. A lot invest their child benefit each month, too. If you look at things like university fees, to fund something like that you probably need to be doing the maximum CTF investment and more to cover those potential costs in 18 years’ time.’

Of course the investment does not have to stop at 18. Parents have plenty of time to help their children appreciate the value of saving and investing. For those not in dire
need of funds at the age of 18, the potential to keep building on that pot of money should be appreciated.

‘The government has said CTF investments will be eligible for transfer to an ISA,’ points out White. ‘We think the youngsters should be able to do what they like with the money at 18, but we also think they should be encouraged to keep the pot going if they can and this solution keeps the money in the tax-efficient world.’

In addition, children can get involved in the investment process as they get older, and learning about saving and investing is one of the best things they can do to put some more control in their lives.