How to save for your child’s future

There are many options to consider when saving for the day your baby becomes an adult, says Rob Griffin
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The Independent Online

Individual savings accounts (ISAs) have revolutionised the way we put money away – and the launch of similar products for children is expected to radically change our approach to setting our offspring on the road to financial freedom in later life.

Plans for tax-free children's savings accounts, to be known as Junior ISAs, were unveiled by the Government at the end of last year. The first such products are expected to become available from autumn 2011. While the full details have yet to be published, it is understood that investments will be available in cash or stocks and shares, annual contributions will be capped, and the child will not be able to access the tax-free funds until adulthood. The new accounts won't receive any Government contributions, but should help fill the gap left by the end of Child Trust Funds in January this year. The investment community has given them a cautious welcome.

However, parents and other close relatives should also consider the alternatives when they're setting up savings and investments on behalf of children.

First you need to understand some rules. In the same way as adults, children have a personal allowance, which is £6,475 for the tax year 2010-11. This is the amount of income they can receive tax-free. A parent or step-parent can give their child as much money as you like – or invest it on their behalf – but if it earns more than £100 interest a year then it will be taxed as if it's your own. However, this limit only applies to parents and step-parents. Grandparents and other adults who give money to them won't be liable for the tax.

The main issue when you're deciding what type of investment is right for your needs will be its suitability, according to Justin Modray, founder of the financial advice website Candid Money. "If they won't have access to the money for 18 years, then you can probably afford to take some risk and invest in stock markets," he says. "However, if they are already teenagers and might need the money sooner, then a safe savings account is more likely to be the sensible option."

You also need to decide when you want your child to be able to get their hands on the money, he points out, adding that if you hold investments via a designated account or bare trust then the child will usually take ownership when they reach 18 years old. "If you want more specific control you'll need to consider using a discretionary trust, although this may not prove cost effective on smaller sums," he adds.

So let's take a look at the relative pros and cons of the main solutions.

Bank and building society accounts

A basic bank account might not pay huge amounts of interest, but it can still be a good idea, argues Mel Kenny, director and a chartered financial planner at Radcliffe and Newlands. "It is good for the child to engage with a bank early on and while it should not be the main driver behind which bank to choose, those that engage with children through gimmicks will probably instil a better savings mentality."

Child Trust Fund

They may no longer be available for babies born today, but anybody can put money into an existing Child Trust Fund. However, there is a limit of £1,200 a year for all contributions. There will be no tax to pay on any interest or gains. Your child will be able to withdraw the money from the account when they reach 18.

Index-linked Savings Certificates

Between £100 and £15,000 can be invested for three or five years in National Savings and Investments (NS&I) index-linked savings certificates. The value of the investment is guaranteed to stay ahead of inflation when held for at least a year.

Premium Bonds

Anyone – including children – can own between £100 and £30,000 worth of NS&I Premium Bonds. They don't accrue interest, but each bond number is entered into a monthly, tax-free prize draw. A parent or guardian must hold the bond on the child's behalf until they reach 16 years old.

A stakeholder pension

This could be a good option for those with newborn babies, suggests Andy Gadd, head of research at Lighthouse Group. "It is a flexible, tax-efficient savings plan that allows an individual to save for their retirement," he says. "They are also great for grandparents who are generally very aware of the importance of saving for retirement and may be keen to make gifts to reduce their inheritance tax liability."

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