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Spend & Save

A savings plan will make a big difference to a small miracle

In the first of a special series on investing for children, Sam Dunn looks at how to give your newborn child the best start in life

Your newborn baby won't only turn your whole life upside down. Your bundle of joy will have you turning your wallet inside out as well.

Your newborn baby won't only turn your whole life upside down. Your bundle of joy will have you turning your wallet inside out as well.

From clothes to food and from toys to buggies, babies are expensive, and parents must be prepared for their spending to rocket. "A baby means a new financial habit," warns Sue Whitbread of independent financial adviser (IFA) Chartwell. "Any budget you ever had before now will go out the window."

From the day he or she is born up until the age of five, parents will spend on average nearly £47,000 on their child, according to Liverpool Victoria friendly society. If that sounds astronomical, a recent survey from the high-street retailer Woolworths suggests you need a mind-boggling £164,000 - more than the average UK house price - to raise a child to the age of 21. This figure includes university costs.

Savings can help limit the damage but four out of 10 parents don't save any money for their children, says the Association of Investment Trust Companies. But then, not everyone can afford to; with so few people having adequate savings on their own behalf, it's no wonder many fail to put enough aside for their offspring.

This concern lies behind government plans to introduce the child trust fund (CTF) from January 2005. A £250 voucher (£500 for low-income families) will be handed out to the principal carer of all babies born since September 2002.

The intention is that this cash will be invested in share-based funds, growing free of tax until the child reaches 18. Generous grandparents and friends are also allowed to invest up to £1,200 a year in the child's fund.

While it is hoped that the CTF will kick-start a national savings habit, any regular saving for your new baby will go a long way towards a deposit on a house, car or university costs later in life, says Meera Patel of IFA Hargreaves Lansdown.

"You don't have to be wealthy to save for youngsters," she says. "You can start with as little as £10 or £20 a month."

Start early, she advises - wherever you decide to put your money. There is plenty of choice but if you want to save for your child until he or she is 18, Ms Whitbread strongly recommends investing in a stock market fund. "With an 18-year timeline, there is no question but to look at an equity-based fund - over that time frame, it should outperform all others."

Watch out for specialist children's investment and unit trusts such as the Rupert Children's fund (Invesco Perpetual) or Jump (Witan), which can be little more than marketing tools.

"Look beyond the packaging," says Ms Patel. "They can often be diabolical performers. Focus instead on something not too aggressive, such as Lazard UK Alpha fund, that will make for a core solid investment."

By putting such a fund in your name on behalf of your baby, you can create a "bare trust". All income and capital within the trust passes direct to your child at the age of 18, and when the investment is cashed in, any growth will be treated as the child's and won't eat into your own capital gains tax allowance.

You could also opt for a special tax-free savings plan or bond for children, available from friendly societies. These let you save up to £25 a month tax-free for at least 10 years, either in a deposit account or in a fund linked to the stock market.

IFAs tend to be lukewarm about such schemes, however, because they carry an element of life insurance, and the tax benefits can be eaten up by high annual charges.

Other savings options favoured by parents include savings certificates and children's "bonus bonds", issued by National Savings & Investments (NS&I), because of the capital guarantees and tax breaks. NS&I's current issue 15 pays 4.7 per cent interest annually (with interest compounded).

Alternatively, there is nothing wrong with choosing a high-interest savings account for your child, says Ms Patel. But if you do so, make sure you sign an IR85 form, available from banks, building societies and tax offices, which exempts the interest from tax. Watch out, too, if your contributions to the account generate more than £100 a year in interest, warns Andrew Shaw of chartered accountant Kingston Smith. Anything above this amount is taxed at a basic rate of 20 per cent and deducted from your baby's account.

If you are a higher-rate taxpayer, you'll have to declare this savings account on your self-assessment tax return and pay the difference, adds Mr Shaw. However, grandparents and generous friends can invest as much as they want into your baby's account and the interest won't be taxed.

If you are happy to invest for the long term, you can help your offspring from cradle to grave by putting money into a stakeholder pension on their behalf. Up to £2,808 can be invested each year, which attracts tax relief. But remember, your offspring won't be able to get their hands on the cash until at least their 50th birthday.

Next week: savings accounts for 7- to 11-year-olds