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Ride out the CTF uncertainty

To combat the ballooning budget deficit two of the main political parties plan to curtail child trust funds (CTFs) should they get into power after the next election.

The Liberal Democrats would end government payouts into CTFs - currently every child born on or after 1 September 2002 gets a £250 voucher from the government to start their fund, or £500 if they are from a lower-income family. At age seven, children receive a second payment from the government. The Liberal Democrats have confirmed that they would maintain the CTF wrapper, so you could continue to invest up to £1,200 of your own money into these every year, without incurring tax on income and gains from investments held within - similar in principle to an individual savings account (Isa). Although stocks and shares Isas are not available to anyone under 18, and you have to be over 16 to invest in a cash Isa.

The Conservative party, meanwhile, would cut government contributions to CTFs for all but the poorest third of families (those earning less than £16,000) and disabled children.

The legislation would be unlikely to be retrospective, according to Martin Shaw, chief executive officer of the Association of Financial Mutuals, so existing CTFs should not be affected, although it is unclear as to whether these vehicles will receive the second payment when the child reaches age seven. Regardless, if you have not yet claimed your voucher and started a CTF, do it as soon as possible as you may only have a few months left. Also, the earlier you start saving for your child the more you will generate for them over the long term.

Stakeholder or self-select?

Once you have your voucher, you have to choose between one of three types of CTFs. Savings accounts CTFs only hold cash within the wrapper, and advisers do not recommend this as a CTF has an 18-year life and the interest earned on cash is likely to be outpaced by inflation. Provider fees for the wrapper can also eat into returns, so it is better have an account with the potential to generate higher returns.

Stakeholder CTFs invest the voucher and invest in equities on your behalf, via a number of funds to reduce the risk. Thirteen years into the life of the CTF, the portfolio is shifted to lower-risk investments such as cash to protect the gains made over the last five years, similar to so-called 'lifestyling' funds.

The downside to stakeholder CTFs is that you cannot choose the underlying funds. In contrast, a non-stakeholder CTF offers you a range of funds - and you can choose. However the charges are not capped at 1.5 per cent a year, as is the case with stakeholder CTFs. The non-stakeholder charge is usually a percentage of its value, and can get pricey.

Jason Witcomb, certified financial planner at independent financial adviser (IFA) Evolve, says as you can only invest at most £1,200 a year into a CTF, high charges are not justified as they will only eat into a higher proportion of the savings.

When you switch funds you will incur more expenses - some unit trusts and open-ended investment companies (Oeics) have initial fees as high as 5 per cent, as well as annual management charges. Mr Witcomb suggests a stakeholder account, especially as there is little value in switching between different funds in the first 10 years of the fund when amounts held in a CTF are relatively modest.

That said, with a non-stakeholder CTF you could opt for lower cost funds such as trackers, exchange-traded funds (ETFs) or investment trusts, although your total cost may still not be as low as a stakeholder. Some investment trust providers offer CTFs and or designated savings schemes. Further details can be found on the Association of Investment Companies website at http://www.theaic.co.uk/Press-centre/Investment-Companies-A-Christmas-present-that-could-last-a-lifeline/. You can get more information on CTFs at http://www.childtrustfund.gov.uk/.

Beware the 'motorbike' fund

CTFs are less flexible than other forms of savings accounts: you cannot access the funds until the child in whose name it has been opened turns 18, at which point your child gets unrestricted access to the money. This means the CTF could potentially become what Martin Bamford, managing director of IFA Informed Choice, describes as a "motorbike fund" for the child, rather than what the parents have in mind, for example, university fees or a deposit for a first home.

He says some parents are so concerned at the lack of control they have over the CTF they only invest the £250 start-up voucher and build up savings elsewhere for their children. There are efficient ways to build up a savings portfolio outside a CTF, which could also be a useful option after the election if you are no longer entitled to a CTF.

National Savings & Investments Children's Bonus Bonds do not incur any income tax or capital gains tax (CGT). You can invest up to £3,000 per issue and get paid a fixed rate of interest for five years and a bonus after five years. At this point you can cash in the bond or roll over on new terms. However, these pay a relatively low interest rate of 2.5 per cent - and therefore do not currently beat inflation.

Friendly Societies' tax-free savings plans allow you to invest £25 a month, but make sure you check the charges on these as they can vary.

Other tax-efficient strategies

You could also set up a designated portfolio of funds and mitigate the tax on these by investing in the accumulation units which incur CGT, currently set at 18 per cent, rather than the income units which incur income tax. You could then offset this against your CGT allowance, currently £10,100 per person or £20,200 between two parents. "Most parents do not use up their allowance on their own investments so using this you are likely to be able to offset any CGT the portfolio incurs," says Mr Bamford.

There are also some bond funds that are based on income generating assets, which offer accumulation as well as income units.

Another option is to hold the portfolio in the name of whichever spouse earns less and offset it against their personal income tax allowance - currently £6,475 a year. If the spouse in whose name it is held doesn't work, then this would almost certainly offset any income tax incurred.

Children have the same allowance for income and annual capital gains tax as adults, but using this would involve holding assets in their name, thereby losing some of the control for the parents, while children cannot invest in as a wide a choice of investments as adults. It is also not a good idea to gift savings to your child because if it generates more than £100 a year in interest, the interest is taxed as income received by the parent - not the child.

Regardless of whether you have a CTF, portfolio of funds or mixture of both, Mr Bamford says the key is to have a clear saving objective in mind to work towards.

Pensions for children

It is also possible to save up to £3,600 a year into a stakeholder pension on behalf of your child, on which even a non-earner gets basic-rate tax relief. There are no exit or transfer penalties so it could be rolled over later in life, for example, into an employer scheme or a self-invested personal pension (Sipp). In the latter case could be used to purchase a commercial premises, if your son or daughter becomes an entrepreneur.

However, a pension cannot be accessed until retirement age, currently 55, a limit which could rise, and Mr Bamford advises that you should not save into a pension for your child unless you have spare cash.

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By Leonora Walters,
26 April 2010

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