Head start for the Blair babes

As the Government launches its new £500 Baby Bond, Clare Francis considers the options for parents investing on behalf of children

As part of its commitment to create a nation of savers, the Government is proposing to give every new-born baby up to £500.

As part of its commitment to create a nation of savers, the Government is proposing to give every new-born baby up to £500.

The Baby Bond, details of which were released last Thursday, will be invested in a Child Trust Fund designed to give each child an endowment that will mature at either 18 or 21 (the exact age has not yet been decided). It is proposed that a further £100 will be added on the child's fifth, 11th and 16th birthdays.

Payments are targeted at families on lower incomes, but children of wealthier parents won't miss out: they will receive £250 at birth plus a further three payments of £50 each. Parents and grandparents will be able to contribute to the fund if they wish.

In order to encourage those on lower incomes to save on behalf of their children, the Government has also announced its intention to launch a Saving Gateway, whereby it will match the contributions made by parents.

Both schemes, which are currently in the consultation stage, reflect a growing need for people to take responsibility for their own future. While it is crucial to save for retirement, it is also becoming harder for young adults to cope financially as the cost of living escalates. Consequently, an increasing number of parents are being forced to save for their children's future, to help meet the cost of higher education or to ease the financial struggle young people face when they leave home.

Those parents who begin saving from the moment their child is born have greater flexibility when deciding where to invest. There are various options available, particularly if you are planning to keep the money invested until your child, or grandchild, is at least 18. This sort of time scale is perfect for equity investments such as unit and investment trusts and open-ended investment companies (Oeics).

Ian Howe at independent financial adviser (IFA) Towry Law stresses the advantages of getting off to an early start. "There is a fantastic array of choice," he says, "and you can be as speculative or cautious as you want."

Traditionally, National Savings products have been used as savings vehicles for children. Returns are tax free but in recent years rates have dropped considerably. The National Savings Children's Bonus Bond is currently paying 4.45 per cent interest. The maximum you can invest is £1,000, and this sum cannot be accessed for five years.

Friendly Society baby bonds, such as those from Tunbridge Wells Equitable, have also been popular investment vehicles. But despite the fact that they are tax free, they are quite inflexible and charges are relatively high. Your money must be invested for a minimum of 10 years and you cannot pay in more than £25 a month.

Michael Owen, director of IFA Plan Invest, believes managed funds are a better option as returns tend to be higher. Some funds, such as the Witan Jump scheme or Invesco's Rupert Bear fund, are designed especially for children. However, while Mr Owen likes the Witan fund, which is cost effective and has a good track record, he suggests such funds may not be the best option.

Rather than opt for a fund specifically for children, Mr Owen advises parents to choose a quality fund with low charges. Donna Bradshaw, director at IFA Fiona Price & Partners, agrees.

"Don't go for gimmicks ­ go for performance," she says. "A tracker could be ideal. Charges are low and over time [these funds] are likely to perform as well, if not better than, managed funds. Alternatively, take a punt and go for higher risk by investing in something like a biotech fund. Another option would be an ethical fund, as children are likely to be interested in this and it's a good way of involving them and educating them about equities as they get older."

Parents or grandparents can set up the fund in their own name but designate it to the child, who can access the money at the age of 18 (or 14, if they invest with M&G). However, Mr Howe points out that you may not want your child to be able to access the money at 18. If you want to keep control of it, you can put it in a bespoke trust, enabling you to stipulate when you want the money to be made available and how much you want your child to have. But the downside is that you need to invest a significant sum ­ around £100,000 ­ as these trusts are expensive to set up and to run.

Another alternative is to put your children's savings in your name. "A tip for parents is to maximise their individual savings account (ISA) allowance each year and then choose how much they want to give their children and when they want to give it to them," says Ms Bradshaw.

You could also consider setting up a stakeholder pension for your child. This is a very tax-efficient way of saving and is likely to build up a significant amount of capital. However, be aware that it cannot be accessed until your child is 50.