Providing a nest egg is kids' stuff
With foresight and regular investment you could give your baby a financial flying start in life, says Chiara Cavaglieri
Saturday 20 July 2013
All eyes are peeled for the imminent arrival of a Royal baby, but if you're expecting your own little bundle of joy, how do you build them a nest egg? Paying for driving lessons and education seems a long way off, but if you get it right from day one, you won't have to scrimp later down the line.
Tax relief is important to any saver and the obvious vehicle for youngsters is now the junior individual savings account (Isa). The current annual allowance is £3,720, rising with inflation every year.
There is no capital gains or income tax to pay, and you can choose whether to save into a cash-based account, stocks and shares, or a mix of both by splitting the contribution (although only one stocks and shares junior Isa and one cash junior Isa can be held at any given time).
It's also the ideal opportunity to take more risk – shares produce a better return than savings accounts over the long term. If you invested the maximum £310 per month and it grew by 7 per cent per annum, over 18 years you would end up with £134,302.
"For junior Isas we like global-equity funds. By their very nature, investors are going to start with a small pot of money, so a global-equity fund gives you decent diversification and exposure to equities, which should do better than other asset classes over time. Our favoured global-equity funds include Rathbone Global Opportunities and Newton Global Higher Income," says Darius McDermott, of IFA Chelsea Financial Services.
An emerging-market equity fund is likely to be highly volatile, but the long-term prospects are attractive and you can drip-feed money on a monthly basis and smooth out volatility by pound-cost averaging.
"For investors who are much more cautious, we'd suggest a multi-asset fund like Artemis Strategic Assets (which is mainly equities but will invest elsewhere if markets suggest a good idea) or a fund like HSBC Open Global Return. Again you get diversification and the ride should be less bumpy," says Mr McDermott.
Children's savings accounts
Government-backed National Savings & Investments (NS&I) offer further tax-free savings – the current issue 35 of the children's bonds for under-16s pays 2.5 per cent for five years on balances from £25 to £3,000. Withdrawals aren't allowed, but the account can be closed early, subject to a penalty of 90-days' interest. Parents, guardians and (great) grandparents can also invest in NS&I premium bonds on behalf of under-16s and again, prizes are exempt from income and capital-gains tax.
Banks and building societies market their own savings accounts specifically for children, but here you do need to think about tax. It is a misconception that children don't pay tax – children, like adults, have their own annual income-tax allowance, so only the first £9,440 from savings, earnings and investments is tax free. In reality, most children never exceed this limit and you can simply ask the bank for an R85 form so they receive gross interest without any tax deduction. The other consideration is how much you are likely to give them, because if they earn more than £100 interest a year from money given by a parent or step-parent it will be taxed at the adult's rate (grandparents and other adults can give as much money as they like).
A pension for your baby
You can also save up to £3,600 a year into a stakeholder or self-invested personal pension (Sipp) on behalf of your child. This time, they don't get access to the money until at least age 55 so the opportunity for growth is astounding. For example, if you were to invest £300 a month for the first 18 years of your child's life it would cost you £52,000 net, but assuming 7 per cent growth and 1.5 per cent in charges, by age 65 they would have a pension pot of £1.8m.
Grandparents can help out too and use their £3,000 annual inheritance tax allowance to fund a junior Isa for their grandchildren.
"Parents or grandparents who are fortunate enough to have disposable income to save for the next generation can give their children a head start by investing in a Sipp. It is not only a good investment, it is also an extremely tax-efficient way to pass money on," says Tom McPhail at Hargreaves Lansdown.
A pension isn't as flexible as an Isa and of no use when it comes to university fees or buying a first home.But you do get tax relief on the contribution, on growth and a 25 per cent lump sum which can be taken at retirement. With such a long time to ride out volatility you can afford to be more adventurous in terms of risk – Mr McPhail suggests a possible portfolio of First State Global Emerging Market Leaders, Lindsell Train Global Equity and Marlborough Special Situations.
Encouraging good financial habits
Teaching children about money matters instils good financial habits. Technology can help here – there are useful smartphone apps to help parents teach children about money-management skills, including The Lemonade Stand, Allowance Manager, Cafe Boss and Mindblown Life.
"With my own children I use PKTMNY – they do chores for their pocket money, are offered 'ad hoc' bonuses for bonus chores and use their PKTMNY cards to spend and to save up on. Similar pocket money solutions include Virtual Piggy and Rooster Bank," says Holly Seddon, editor in chief at parenting site www.quib.ly.
That said, don't forget to let your children handle real cash by getting them involved in weekly shopping trips, encouraging them to save up for treats and helping them to budget in the real world.
Junior ISAs: The facts
1 Junior Isas replaced child trust funds (CTFs) in 2011. The current annual allowance is £3,720, rising with inflation every year.
2 Parents with an existing CTF cannot take out a junior Isa as well, although the Government is currently consulting on whether they should be merged.
3 Teenagers aged 16-18 can also hold both a junior Isa and an adult Isa, benefiting from an even bigger tax-free savings allowance.
4 You can transfer money between junior Isas so if you wish you can change the fund in which your child’s savings are invested, or if you find a cash account with a better rate, you can move the money (although you must transfer the savings in full).
5 You can also transfer junior Isas from cash to stocks and shares and back again, unlike adult Isas.
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