The gift that keeps giving

Investments for children at Christmas can grow up with them. Choose carefully, warns Dido Sandler

WHICH kid's Christmas present will never fall apart, run out of batteries, or be discarded by the end of the 12th day?

The answer is children's savings and investments, which will actually gain interest instead of losing it as time goes by.

Christmas has long been a time for parents, grandparents and friends to put something away for the little dears. Modest investing for the duration of a childhood can build up surprisingly large returns. For example, pounds 1,000 put into the giant stock market-invested fund, Foreign & Colonial, 10 years ago would be worth more than pounds 5,000 today. And the gift will prove an excellent memento when eventually the grandchild draws on the cash, perhaps for university, or travelling, or getting married.

If preparing to cough up, however, givers should beware the marketing hype surrounding some savings and investment products aimed specifically at children. This can disguise some uncompetitive investments. And many investment choices available to adults can also be bought for children (although a notable exception is PEPs).

The Rupert Bear children's unit trust from Invesco, for example, promises free posters and birthday cards, as well as a low minimum investment. But it came only 123rd of 126 funds in its peer group over the past three years, and 104th of 118 over five years. The West Bromwich building society may give the child a moneybox when a Mr Money account is opened. But at 0.60 per cent on amounts above pounds 1,000, the interest rate is pitiful. By comparison, the Skipton building society offers 5.75 per cent on deposits of more than pounds 25, but gives no freebies.

If you intend the money to be locked up for longer than five years, it's worth considering stock market investments such as unit and investment trusts. These should outperform savings accounts over the longer term.

For shorter periods, building societies or National Savings are a better idea. The trouble here is that interest rates - already quite low - are on the way down. The National Savings Children's Bond currently offers a fixed return of 7.85 per cent a year tax-free for tying up money for five years.

The maximum holding is pounds 1,000. But hurry: this issue may be closed shortly, and replaced with a lower rate bond.

Friendly society baby bonds allow adults to invest pounds 25 per month with returns tax-free on behalf of children. As with endowment policies, bonds are either on a safer but less spectacular with-profits basis, or are unit-linked, with greater risks from direct exposure to the stock market but better potential gain. However, the benefits conferred by tax-free status are undermined by onerous charges. Unit and investment trust savings schemes offer more flexibility - for example, you may hand over money when you want - not necessarily every month as in friendly societies.

Unlike savings accounts and National Savings, however, unit and investment trusts may not be held directly by a child, but must be registered in an adult's name. Such gifts should be clearly earmarked for the child to avoid the risk of the parent facing a tax liability on the returns. This is normally done by putting the child's initials after the name of the adult purchaser. It is also worth holding these investments in what is normally known as bare trust, particularly if you are a parent (see box), to ensure the child can claim back tax deducted from any income paid out by the investment. The trust states that the beneficiary of the investment is the child, even though it is legally owned by the adult.

Midland Bank has just launched a unit trust plan for children which takes care of bare or flexible trust arrangements for you.

Bare trust forms are also available from the Association of Unit Trusts and Investment Funds, as is a free fact sheet on saving for children. Telephone 0181-207 1361.

And finally, if you want to instil the gambling habit in your children early on in life, you should buy them Premium Bonds from National Savings. The National Lottery bars the under-16s. National Savings prizes amount to an effective (average) interest rate of around 5 per cent tax-free, with the top prize of pounds 1m each month. The minimum purchase is pounds 100.

Children's accounts

Account Rate % Incentives

High Street

Bank of Scotland, Supersaver 4.25 Backpack, management folder, magazine

Barclays Bank, Barclayplus 4.00 pounds 5 voucher, magazine

Coventry BS, Interest Zone 5.00 -

Halifax BS, Little Xtra/Quest 3.90 Moneybox, bike sticker, badge, magazine, cards

Skipton BS, Young Sovereign 5.75 -

Woolwich BS, Woolwich for Kids 3.90 Moneybox, birthday card, magazine

Others

Cambridge BS, First* 6.30 -

Chorley & District BS

Young Chorleian* 6.85 -

Harpenden BS, 18 Club 6.75 (B) -

Melton Mowbray BS, Sunny Bond 7.10 (C) Gift according to age, birthday card, newsletter

Tipton & Cosely BS, Cash Zone 6.00 Sticker set

Universal BS, Childrens 6.40 pounds 1 donated to Yellow Brick Road campaign

* Available to local residents only; (B) No withdrawals permitted until 18th birthday; (C) Min deposit pounds 250 Source: Moneyfacts

TAX TIPS

Children are entitled to a personal allowance - up to pounds 3,525 income tax-free (pounds 3,765 next year) - and their own tax-free capital gains allowance of pounds 6,000 (pounds 6,300 from April).

Most deposit interest and investment income is paid net of basic-rate tax, however. The account holder can be registered as a non-taxpayer by filling in Inland Revenue form R85 so that interest is paid gross, or reclaimed using the same form. For reclaiming tax on income from unit and investment trusts, use form R232.

If investment gifts from parents produce more than pounds 100 gross income a year, the whole of the income is taxed at the parent's highest rate of tax. The child cannot reclaim any of that tax. Some investment gifts from parents may be put into bare trusts until the child is 18, which avoids this.