If you're investing for a child, then the child trust fund (CTF) has to be considered. But it is not necessarily the best place for your investment. Before CTFs came along, if you wanted the money you give to be the child’s property, the simplest way to do this was through a bare trust - and this is still an option for parents and grandparents.
A bare trust is very similar to a CTF. The investments are in your name, but you hold them in trust on behalf of the child.
Neither you nor your child will pay tax on income or capital gains generated within a CTF account. But taxation of a bare trust is not as simple as a CTF.
A bare trust is treated as the child’s for tax purposes, which can be particularly useful if you are likely to be making full use of your own annual capital gains tax (CGT) allowance or are a higher-rate taxpayer. When the child reaches 18, they gain full control of the investments.
So what tax advantages does the CTF have over a bare trust?
Income tax
Let’s look at income tax first. If the money in a bare trust was given by a parent and it generates annual income of more than £100, it will be taxed as the parent's own. But this £100 rule applies only to parents, not to grandparents. If grandparents are investing, they won't be liable for tax and as children have their own tax allowances, it is possible to use the child's income tax allowance (currently £6,035). Taking all of this into account, the CTF has a small advantage in income tax over the bare trust.
Capital gains tax
With capital gains tax, though, it is not so clear-cut. Any capital gains are completely exempt from tax in a CTF account, which sounds brilliant until you realise that at £1,200 maximum investment a year you would need phenomenal growth in a CTF before the CGT exemption is worth anything. Bestinvest calculates that a £250 CTF contribution at birth/age 7 plus £1,200 each year will grow into £40,500 assuming an annual return of 6 per cent net of charges. Is this realistically going to generate annual capital gains over the £9,600 annual allowance? In a bare trust children have their own capital gains tax allowance (£9,600) which is probably enough to keep any growth out of the tax regime. So the CTF capital gains tax advantage is slim.
Inheritance tax
With inheritance tax (IHT) too, the CTF has no advantage over a bare trust. Each person can give away up to £3,000 every year without any IHT consequences. If you are giving money to a child over this limit through a bare trust or CTF, it is considered outside your estate for IHT purposes - as long as you survive for seven years after the gift is made. The CTF is subject to the same rules.
In conclusion, while for parents investing for children, a CTF has slightly better tax treatment, for grandparents investing for children there is little difference between a bare trust and a CTF.
Choice and charges
However, a bare trust has massive advantages over the CTF in charges and investment choice. Adrian Lowcock at Bestinvest says: "Once you have the government £250 vouchers, the advantages and disadvantages of going into a CTF with extra money are marginal. Compared with a bare trust, there's not a lot of choice as the industry can't offer them profitably."
To get maximum investment flexibility within a CTF, you could open a stocks and shares CTF with a handful of stockbrokers. But as you are only dealing small amounts, this could be expensive.
A problem with the CTF for those contributing the maximum £1,200 a year is the lack of investment fund choice. For example, F&C is the only fund management group to offer CTFs.
In contrast, any fund can be set up as a bare trust for a child. There is no extra cost or paperwork involved.
Best Child Trust fund options
Here are some of the best fund options within the CTF:
Tracker fund
Avoid CTFs that charge an outrageous 1.5 per cent annual fee for a FTSE tracker fund. The cheapest CTF tracker fund is from the Share Centre, which offers the Legal & General UK Index Fund at a discounted rate of 0.6 per cent a year.
UK growth
The Children's Mutual has managed to bag a good range of actively managed funds from four fund managers for its CTF offerings. The one that stands out is Neil Woodford's Invesco Perpetual Income Fund. However, it isn't discounted so you pay the full initial charge of 5 per cent and an annual management charge of 1.5 per cent. However, if you set up a bare trust via the Hargreaves Lansdown Vantage fund supermarket the initial charge on the Invesco Perpetual Income Fund would be 0 per cent and the annual management charge would be 1.25 per cent.
Overseas growth
Most investors are too UK centric and you probably ought to be diversifying overseas for your child. F&C offers a range of 14 globally diversified investment trusts for its CTF option. Its most popular CTF option is the internationally diversified Foreign & Colonial Investment Trust, where the total expenses are just 0.53 per cent, almost certainly making it the lowest-cost managed-fund option within any CTF. F&C has no initial or annual management charges for its shares CTF plan.
Jump Child Trust Fund is based on Witan Investment Trust, a leading global investment fund that invests in hundreds of blue-chip stocks and shares, spread across the world’s markets to minimise risk. However, it is much more expensive than the F&C CTF. In addition to Witan's total expense ratio (TER) of 0.53 per cent, Jump charges a £10 (+VAT) voucher processing fee and a 1 per cent annual management charge subject to a minimum of £10 (+VAT).
