Why it pays to save for your kids

Investing for children is complicated as more firms pitch for the junior market

Savings and investments for children are traditionally squirreled away in the simplest of safe places, not much further along the evolutionary scale than the piggy-bank. After all it would not be the best of examples to an innocent financial mind if grandpa lost the child's first ever nest-egg with a wild speculation. So mini-accounts with banks and especially building societies are usually the instinctive first choice of the doting relative, with friendly societies and National Savings for longer-term savings.

Savings and investments for children are traditionally squirreled away in the simplest of safe places, not much further along the evolutionary scale than the piggy-bank. After all it would not be the best of examples to an innocent financial mind if grandpa lost the child's first ever nest-egg with a wild speculation. So mini-accounts with banks and especially building societies are usually the instinctive first choice of the doting relative, with friendly societies and National Savings for longer-term savings.

Banks and building societies in turn have pitched for kiddy cash with accounts which often allow children to withdraw and deposit cash so that they can get used to the idea of managing money. They throw in a range of perks such as cuddly toys and pencil cases, designed to make the kids feel special and buy their loyalty for life. There are some decent rates of interest available. Dunfermline Building Society is currently offering 6.6 per cent gross on an investment of £500 in its Children's Bond, with the interest paid annually. Abbey National's Savings Bond will pay a fixed rate of 6.25 per cent gross for five years on a deposit of £500 with the interest payable on maturity. The Nationwide's Smart 2 Save account pays 6.2 per cent payable half-yearly on as little as £1, with instant access.

Friendly societies also pitch for investments on behalf of children, taking advantage of rolled-up income and built-in tax advantages which are available and help to offset the rather high management charges. The policies are free of tax provided the monthly investment is no more than £25 or £270 a year and contributions are kept up for at least 10 years and until the bond matures. Tunbridge Wells Equitable this week launched its own website (www.babybond.co.uk) to promote its Baby Bond, a with- profits endowment policy in the child's own name and designed to pay out on the child's 18th or 21st birthday.

National Savings Children's Bonus Bonds can be bought on behalf of a child up to the age of 16, as well as by the children themselves if they get the consent of a parent or guardian. Bonus bonds are owned by the children but they are controlled by the parent or guardian up to the child's 16th birthday. They are also tax-free, and the new Issue P, announced last week, pays 5.25 per cent fixed for five years on a minimum investment of £25 up to a maximum of £1,000, with the interest added on maturity.

The combination of low rates on deposit accounts and limits on the amounts which can be invested in tax-efficient investments means that even regular monthly contributions might not be enough to buy "Little Willie" that car he will be wanting when he reaches 16, or to pay his way through University for a couple of years. To build up big money the practical benefactor nowadays needs to invest in equities and let the miracles of pound-cost averaging, reinvested dividends and time do their work.

Children are entitled to their own tax-free personal allowances and capital gains tax allowances, but they are not legally allowed to own shares until they are 18 in England & Wales (16 in Scotland). The same applies to investment trusts and unit trusts, but parents or guardians can control the investments until the child comes of age. If parents invest money on behalf of their children any income over £100 a year is considered to be part of the parents' income and is taxed, so the smart move is to get grandparents or other relatives or friends to buy the assets. They can buy units on behalf of children using a designated account, with the units registered in the buyer's name but initialled to indicate the child is the beneficial owner. Any gain can then be put against the child's full tax allowance.

Until recently, product providers made no real effort to tap this market. The fund manager, Invesco, operates a "Rupert Bear" fund which in return for a minimum investment of £1,000 sends the lucky child a toy bear and an annual birthday card. The initial charge is 5.25 per cent and the annual charge a rather high 1.25 per cent but funds are invested mainly in FTSE 100 stocks, returns have been quite satisfactory and the product has been unique in targeting the children's investment market.

Things may now be set to change with demand and supply both working together to make the market grow. Fund managers Henderson have just launched Jump, its first long-term investment targeted specifically at investors for children. It accepts lump sums of £100 and monthly or quarterly contributions as small as £25. Funds are invested in the Witan Investment Trust which currently holds around 60 per cent of its funds in UK shares and 40 per cent overseas. Dealing charges are just 1 per cent and the annual expenses charge a low 0.3 per cent. There are no special gimmicks but marketing manager James Budden points out that £25 invested monthly over the last 15 years would now be worth £15,370, almost double the return from the average building society.