Once you’ve started saving the pennies you’ll probably want to know how to maximise your investment. There are many ways to invest your savings that have the potential to provide excellent returns, but deciding which route to take depends on you. You will have to think about:
- The period of your investment
- The level of control you want over access to the fund
- Your attitude to risk
What if your child doesn’t qualify for a Child Trust Fund?
If your child was born before September 2002 they won’t qualify for a CTF but there are plenty of options for parents, grandparents and friends to invest on the child's behalf.
Savings Accounts
There are many savings accounts designed exclusively for children, although the rules for adult accounts generally apply to children’s accounts also.
Children have a personal allowance of up to £5,225 for the tax year 2007-8. As long as the interest on their savings (and any other income they may have) is below this amount, they will not have to pay tax and they will be able to claim back any tax they shouldn’t have paid. If the child’s income is above this amount, the interest on their savings will be taxed (at the same 20% as adults’ accounts), but they may be able to claim some tax back because they won’t have used the starting rate tax band (10% on the next £2,230 after £5,225).
There are no limits on how much can be invested in a child’s savings account, but if each parent’s contribution produces more than £100 interest during the year then the whole of the interest earned on the child’s savings will be taxed as if it is the parents’ income. The £100 rule applies to each parent (and each step-parent if applicable). So if one parent contributes enough funds to produce more than £100, the whole amount of interest earned will be taxed. However, if the second parent’s contribution to the account produces less than £100 interest then that amount won’t be taxable and you can reclaim that amount of tax.
The £100 rule doesn’t apply to grandparents and other relatives and friends. However, you should still be aware that any income over £5,225 will be taxed in the same way as an adult’s savings account. Also, should the person making the gift die within seven years, you may also be liable to pay tax on the amount contributed by that person. Grandparents have an annual gift allowance of £3,000 which is exempt from inheritance tax.
It is important that you check your child is entitled to receive interest tax-free and remember to apply to have the interest paid tax-free using HMRC Form R85, which you must give to the account provider once completed. If you need to reclaim some tax you must complete HMRC Form R40.
Many account providers targeting parents of young children will offer gimmicks such as money boxes and toys, but the most important considerations for you include the interest rate and the period it is guaranteed for, the control over access to the account (e.g. at what age will control pass to your child?), the convenience of the account (e.g. online access or a high street branch), how easy it is to transfer the account to a different provider if there are better rates available elsewhere, and finally whether there are any other harsh terms and conditions that make the account inflexible and unattractive.
National Savings & Investments: Children’s Bonus Bonds
This is a particularly tax-efficient option for parents wanting to invest up to £12,000 a year. The bonds are issued 3 or 4 times a year, and up to £3,000 per child can be paid into each issue (minimum contribution = £25). Each issue has its own rate of guaranteed interest for the next 5 years, and there is a bonus if the funds aren’t touched for this period. The interest earned is completely tax-free, and remains so even when the child starts working and exceeds their personal tax allowance. Control of the bonds is transferred to the child when they reach the age of 16 and when the child reaches 21 the bonds mature and the child may have a very generous lump sum.
NS&I bonus bonds are an attractive option for those seeking a safer investment due to their guaranteed interest rate, potential bonuses and tax-free status. Points to keep in mind, however, include the availability of higher interest savings accounts, and the level of trust you have in your child to control the funds wisely from the age of 16!
Individual Savings Accounts
Individual Savings Accounts (ISAs) in your child’s name are only an option once your child reaches 16 (Share ISAs carry a minimum age of 18). Until then you can save on behalf of your child but the account will be in your name. ISAs are another tax-efficient option in that you can invest up to £7,000 each year tax-free.
There are 2 types of ISA: Maxi and Mini. A Maxi ISA can contain a maximum of £7,000, which can either consist entirely of stocks and shares or £3,000 of this allowance can be invested as cash. Alternatively, you can have 2 Mini ISAs with one ISA containing up to £3,000 in cash and the other ISA containing up to £4,000 in stocks and shares. The maximum amount any saver can invest in an ISA in each tax year is £7,000.
There is a huge range of ISAs offering very good returns, and an attractive feature for parents will be the ability to retain control until the child is at least 16. However, with the account being registered in the parents’ names, there may be the temptation to withdraw funds for life’s emergencies and it may be difficult to top up the fund in later years.
Pensions
Investing your money in a stakeholder pension is potentially the most tax-efficient option. You receive tax relief at the basic rate, which applies even though your child doesn’t pay tax, meaning that for every £78 contributed to the child’s pension by parents or grandparents, the government will contribute £22 (basic rate of 22%).
Of course, your child won’t be able to access the fund until they are at least 55 but this is a great option for grandparents who are aware of the importance of starting to save for retirement from an early age. The maximum amount you can pay in each year to the child’s pension is £2,808, which will then be topped up by the government to £3,600. Grandparents have a gift allowance of £3,000 each year and this may be a good way to make use of their generous gift, whilst you focus on saving for the shorter term (18 years will pass by relatively quickly!).
Stakeholder providers are allowed to charge up to 1.5% per year for the first 10 years and 1% per year thereafter. The advantage of starting a pension early for your child is that when your child reaches 18 and takes control of the fund, they are already paying a lower charge per year as they will have passed the initial period of higher charges.
If you are planning to save for your child so that they have a nice lump sum for starting university, buying their first home or starting a business, then this may not be the best option for you due to the inaccessibility until later life. However, this may be something to consider alongside putting some money away each month for their 18th birthday, or asking grandparents to fund, due to the great tax advantages.
Bare Trusts
There are many different types of trust that you can create to hold or manage property on behalf of someone who is not able, or not ready, to manage it themselves. Trusts can be very complicated and therefore it is wise to discuss your circumstances and wishes with a solicitor and possibly an accountant.
A bare trust enables you to hold and manage property on behalf of your child. The trust will be in your name but your child will be the beneficiary. You can hold almost anything in a bare trust including land or property, shares, money or other valuable items such as antiques or art. You will not be able to hold an ISA in a bare trust for the child as these trusts can only hold assets that the child is allowed to invest in themselves, which is not the case with ISAs.
You will have control over the property in the trust until your child reaches 18 (if you have specified this age to transfer control). Until the age of 18 the property will be treated as your child’s for tax purposes, so the income can be tax-free if it falls below their personal tax allowance of £5,225. You can also use their Capital Gains Tax allowance so you may not be liable for this tax either.
We considered the NS&I Children’s Bonus Bonds above, but other NS&I Investments that parents can invest in on behalf of their children include Index-linked Savings Certificates and Premium Bonds.
Index-linked Savings Certificates
Parents can save between £100 and £15,000 for 3 or 5 years in these savings certificates, which are again tax-free. The interest rate is guaranteed for the period of the investment and the return on your investment is guaranteed to be above inflation.
Premium Bonds
These must be held on behalf of the child until they reach 16 by a parent or guardian, although parents and grandparents can both purchase them for the child. The value of premium bonds that can be owned by the child or any individual is between £100 and £30,000. No interest is paid on the bonds, although each bond is entered into a monthly prize draw and the prize is tax-free.