Saving for children has always been popular. The traditional method has been to put money into a dep...
Saving for children has always been popular. The traditional method has been to put money into a deposit-based savings account, but with the future demands for money only increasing, equity exposure has to be a serious consideration. The rules that apply to adults are just as relevant to children get the basics right first, then develop the portfolio.
Children should get into good habits early and adopting a portfolio approach to their money can teach them valuable lessons for later life. Creating a portfolio for children works on a rising scale of risk and commitment. Start with deposit-backed accounts, then move toward equity-backed investments.
Children enjoy having their own bank accounts. It makes them feel important and the interest offered to young savers is also good. The top 50 children's accounts average 5.99% and are not dependent on bonus payments, like most 'adult' accounts. Children should use the account as a current account and start to manage their own finances, however limited.
If larger sums are allocated, then National Savings offers tax-efficient products suitable for a child's portfolio. The maximum unit holding per bond is £1,000 and a bonus is paid on the fifth anniversary. They currently accrue 5.25% interest annually. The National Savings Investment account awards 4.6% for sums of more than £500 and the first £70 of interest is tax free.
It should be noted that children have exactly the same tax allowances as adults, although most are non-taxpayers. Most children will be entitled to receive income gross. If they have a building society account, a parent or guardian should complete Inland Revenue form R85. This ensures that interest is paid without tax deducted until the 5 April following the child's 16th birthday.
If adults, and this usually involves grandparents, want to create a nest egg for their loved ones, some degree of equity exposure would be wise. This is for two very good reasons: greater growth and tax-free products. Investing for children is by its nature long-term and this makes shaping an equity-based portfolio ideal for a child. Children are rarely taxpayers and so it is unlikely they will need to use their CGT allowances when investments are cashed.
There are thousands of equity-based products, but not all are suitable for children. A good start into equity-backed investments is a children's bond from a friendly society. The societies are often overlooked because of the funding limits placed on their traditional plans, but they have advantages.
The ceilings placed on contributions make the products suitable for children. It's a level of funding they can comprehend and is also easily affordable for grandparents. Also, since the bond belongs to the child and has no tax implications for adults, parents or grandparents are equally free to contribute to it. Friendly societies also have some financial muscle collectively they look after some £16bn.
The investment limits are currently £25 per month or £270 per year and the plan must be in force for 10 years to qualify for the tax-free status. Once the 10th anniversary has been achieved, many plans are extendable, some can be left running, and others have a finite term, so it's worth checking with the provider at the beginning. It is possible to arrange for the plan to continue for anything up to 25 years, with tax-free investment continuing right up to maturity. One bond can be allocated per child.
The tax-free growth potential offered by friendly societies can prove especially attractive when it is remembered that ISAs are not available to those under 18 (or from 16 April 2001). The bonds can also be timed to 'mature' on a special birthday 18 or 21, for example so that the tax-free funds are locked away for a time when they are probably needed most, for university or the deposit on a first home.
Fund performance is also generally good. As a sector, friendly societies have consistently outperformed equivalent life funds. Comparisons over three, five and 10 years illustrate the difference (see table).
The Family Friendly Society's C Brit 2 fund has produced a healthy 258% return over a 10-year period, which beats its nearest life competitor, Norwich Union Balanced Managed, by 33%. Upper quartile performance from friendly societies such as this is not as widely known and enjoyed by investors as it should be.
While friendly societies provide a first base for a child's portfolio, they are not the only solution. If there is more money available for investment, there are many familiar products to choose from, but there can be possible tax implications. Children cannot own ISAs, but they are able to own shares, unit trusts and investment trusts. But gifting these products to children carries a tax burden. Income earned by a child on gifts from their parents need special attention: if the income generated by the gifts made by one parent to one child exceeds £100 in any one financial year, the parent is liable to tax on that income. An account that produces this income cannot be registered to pay interest gross, even if the parent's gift comprises only part of the capital.
Most commonly, the investment will be made by an adult on the child's behalf via a designated account that allows the adult to trade, buy or sell, with ownership resting with the child for tax purposes. Most investment houses will be able to smooth the administrative path towards this sort of arrangement. Trusts also have a place in planning for the passage of wealth from one generation to the next, especially if the grandparents are keen to endow their younger relatives. When preparing a legacy of this kind, though, care has to be taken and legal as well as financial advice should be provided.
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