(Published September 2008)
Child Trust Funds
Make the most of the Government's generosity - and your children's future.
Background
Every child born in the UK from 1 September 2002 is eligible for a tax-free savings account, known as a Child Trust Fund, following the launch of the scheme by the Government on 6 April 2005.
The account is started with a £250 voucher from the State, when a child is born and for families with a household income of less than £15,575 in the 2008/9 tax year, this figure rises to £500.
In addition, further contributions can be made, of up to £100 per month, by parents, grandparents or even family friends, with the money growing free of Income Tax and Capital Gains Tax.
Withdrawals are not permitted until the child is 18 years of age, thus removing the temptation to disturb the investment and jeopardise future returns.
The Investment Choices
CASH:
These accounts pay annual interest.
There will generally be no charges to pay, but you should bear in mind that although your money earns interest, it may not grow as much as it would if it was invested in shares.
Savings accounts do not usually perform as well as money invested in shares, over the long term, especially when inflation is taken into account.
STAKEHOLDER:
These accounts invest in shares, aiming for potentially higher rewards than their cash-based counterparts.
However, once your child is 13, money in the account starts to be moved to lower risk investments, such as corporate bonds, to lock in gains as the account approaches maturity.
This means that your child's money may not benefit if the stock market is performing well, although it will be protected from stock market losses, as they near their 18th birthday.
Charges on this type of account are limited to 1.5% of the account's value each year.
PURE EQUITY:
These accounts invest in shares right up to your child's 18th birthday and offer the potential for the greatest returns.
There are no controls imposed on charges, but with plenty of competition between providers, charges tend to be reasonable.
Investing in shares is more risky than putting money in a savings account, as shares can potentially lose some of their value.
However, in the past, money left for a long time in this type of account has grown more than the same amount left in a savings account. This is true for every 18-year period in the last 40 years. (Footnote 1).
The Investment Considerations
Despite there being initial decisions to be made in respect of investment strategy, as with all areas of financial planning, these decisions should be reviewed on an ongoing basis, in accordance with changes to personal circumstances and attitude to investment risk, for example.
In this respect, it is worth remembering that a Child Trust Fund is portable, so if you decide you would like to change your investment strategy, you are free to do so.
It is also important to bear in mind that a second payment of either £250 or £500, dependent on household income, will become due on your child's 7th birthday. This payment may provide a good opportunity to review investment performance and strategy.
The Longer Term
At age 16 your child can take control of their account, deciding how their money is invested. At age 18, the account will automatically convert to an ISA, thus retaining its tax efficient status.
At this point your child will have access to their money for the first time and may withdraw some or all of their funds, as they wish.
Making the most of your Child Trust Fund
Somewhat alarmingly, as many as one in four parents do not use the £250 or £500 voucher to open a Child Trust Fund for their child, within a year of their child's birth, which means they lose control over investment choice and as a result, the decision is taken by HM Revenue and Customs over which type of account your child will have and with which provider.
In addition, the overwhelming majority of families do not make additional contributions to accounts, missing the chance to build a sizeable, tax-efficient nest egg for their loved ones. Indeed, HM Revenue and Customs examined the 744,000 oldest Child Trust Funds - those opened in the 2005/6 tax year - and found that only 15% of accounts were receiving extra payments. (Footnote 2).
Summary
You can take control of planning for your child's future, by utilising the opportunity Child Trust Funds provide.
Seize full advantage of the Government's generosity - after all, when you consider thorny issues such as the level of Income Tax, Inheritance Tax and Stamp Duty families are forced to pay, to name but a few unpopular taxes, being 'generous' is not something they are praised for very often.