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How to save for your children

There are several ways to build up a nest egg for your children
November 10, 2016

On 1 November the junior individual savings account (Jisa) turned five and Premium Bonds celebrated their 60th birthday. But these are just two of the ways you can build up savings and investments for your children.

The first thing you need to decide when putting money aside for your child is whether to hold it in cash or invest it in the stock market.

Figures from asset manager Fidelity show that if you had drip fed the full allowance each year into a Jisa since the scheme was launched - a total of £18,713 - and invested it in a FTSE All-Share tracker fund, your child would have a fund worth £22,895. That compares with just £18,791 if you had left the money sitting in cash - a return on investment of just £78 over five years.

Choosing an actively managed fund could have netted your child even higher returns. If you had set up a monthly savings plan and invested your full allowance in an active fund, for example Rathbone Global Opportunities (GB00B7FQLN12), your child would now have savings worth £27,835, according to research company Morningstar - £4,940 more than a FTSE All-Share tracker and £9,000-plus more than if you'd left your money in cash.

Data from HM Revenue & Customs reveals that 67 per cent of all Jisas are still held in cash. But when it comes to saving for kids you have a long time horizon, which means a long time to build up money in the market - and the need to generate higher returns than inflation.

"Think about what these savings will be for," says Adrian Lowcock, investment director at Architas. "This could be university fees or a deposit for a first home, for example. And as those things are likely to rise above the rate of inflation so your investment really should too."

Low interest rates have also had an impact on children's saving accounts. Comparison website moneyfacts.co.uk has found that more than 100 rate cuts have been made to child savings accounts over the course of 2016 - some as high as 2 per cent - so that a number of savings accounts now pay as little as 0.1 per cent a year. Cash Jisas, meanwhile, have suffered rate cuts of up to 2.25 per cent.

 

Investment options

Junior Isa

Starting a Jisa doesn't have to be time consuming and all you need to start is one fund (see below). You can contribute up to £4,080 per year in the 2016-17 tax year and the investment will grow free of tax.

Tax efficiency is less of an issue for children, who have the same £11,000 personal allowance as adults and generally will not be earning any income.

 

Children's tax allowances

Personal allowance: £11,000

Dividend allowance: £5,000

Personal savings allowance: £1,000

"With the personal allowance, dividend allowance and new personal savings allowance unveiled in the latest tax regime, what's important is that your strategy makes the maximum use of those allowances," says Ms West.

 

However, tax could affect you when gifting money: you will have to pay tax if your child earns more than £100 in interest on assets given by you held outside a Jisa. You would incur tax at your income tax rate.

A simple way to get around that is to opt for funds that accumulate instead of pay out income, or shelter the assets in a Jisa.

Most major investment platforms offer DIY Jisas, including Hargreaves Lansdown, AJ Bell Youinvest, Bestinvest and Alliance Trust Savings.

Jisa pros

■ Tax-efficient saving

Jisa cons

■ Your child gets control of the money at age 18

■ Annual investment limit, currently £4080

■ Stock market risk if invested in funds/shares

 

How to build a Jisa

Building up an investment portfolio for your child doesn't need to be complicated. You can start with just one fund, and you don't need to move in and out of investments to let it grow. It may feel like a high-risk option, but over a long time horizon such as 18 years market fluctuations should help rather than hinder your returns.

"Accept that risk is OK and that over 10 years volatility is your friend," says Petronella West at wealth manager Investment Quorum. "If stock markets fall it doesn't have to mean you've lost your money [if you don't sell at that point], and it's a better time to buy."

Mr Lowcock suggests investing your child's Jisa in one global equities fund until your portfolio reaches £3,000. You could then invest via a core and satellite approach - holding a global equity fund focused on quality companies with good growth potential, alongside one or more higher-risk funds invested in emerging markets or Asian equities.

For the core of a portfolio he likes Fidelity Global Dividend Fund (GB00B7778087) which targets growth and income, or Lindsell Train Global Equity (IE00BJSPMJ28). "I would drip feed money into funds like those at the moment because they are invested in areas that are highly priced," he says.

Mr Hollands also suggests starting with one well-diversified global fund, or two if you want to split your child's Jisa between developed and emerging markets. He suggests Fundsmith Equity (GB00B41YBW71), which targets 20 to 30 companies that are resilient to change, with attributes such as the ability to sustain a high return on operating capital, advantages that are difficult to replicate, no need for significant leverage and certainty of growth from reinvestment of cash flows at high rates of return.

He also suggests JO Hambro Global Opportunities (IE00B89PQM59), whose managers aim for long-term capital and income growth via a relatively concentrated portfolio of global equities. The fund currently has 33 holdings. Its managers take an absolute valuation approach with the aim of avoiding momentum and relative valuation pitfalls.

Other core options include Scottish Mortgage Investment Trust (SMT), which has an excellent performance record, and is differentiated by its increasing exposure to unquoted companies which could give returns an added boost, but also increase the risk of this trust. It has a very low ongoing charge of 0.45 per cent.

Another option is Foreign & Colonial Investment Trust (FRCL), which invests in global equities but also offers exposure to alternative assets such as unlisted securities and private equity. It has also raised its dividend for 45 consecutive years.

The maximum number of funds to consider - after -the Jisa reaches £50,000 - should be 10 to 15 funds. This could be split between:

■ a UK mid and smaller company fund

■ a UK income fund

■ a UK growth fund

■ an Asia and emerging markets fund

■ funds offering exposure to the US, Japan and Europe

■ a gold fund.

 

Investment trust savings scheme

Investment trust savings schemes are an easy way to pay money into an investment trust regularly at a lower cost than buying investments from a platform or broker. Many investment trust savings schemes will only charge you to sell an investment trust and not charge you annual fees, unlike brokers and platforms, which usually charge every time you trade and also levy annual fees.

Another major advantage of these is that you control when the child has access to the money. And by drip-feeding money in on a monthly basis (via direct debit) you are able to average out the highs and lows of the market. These schemes are offered by 10 investment trust providers (see table below).

Minimum investments into children's savings plans start as low as £25 per month and there is no maximum investment size.

The downside of investment trust savings schemes is a lack of investment choice: unlike a Jisa, which you could allocate between a wide range of investments, this option means investing in investment trusts from just one provider.

Pros

■ Controlled access

■ Low cost

Cons

■ Lack of investment flexibility

■ No tax benefits

 

Children's investment trust share schemes

NameMinimum monthly regular savingsMinimum lump sumDividend reinvestmentInitial admin/ annual charges
Aberdeen Asset Managers£30£150YesInitial/Admin: Nil. Annual: Nil.
Alliance Trust Savings£50£50YesInitial/Admin: Nil. Annual: £10 per quarter.
Baillie Gifford Savings Management£25£100YesInitial/Admin: Nil. Annual: Nil.
Dunedin (through Alliance Trust Savings)£50£50YesInitial/Admin: Nil. Annual: £10 per quarter.
F&C Management£25£250YesInitial/Admin: Nil. Annual: £25.
Intermediate Capital Group (through F&C Management)£25£250YesInitial/Admin: Nil. Annual: £25.
JPMorgan Asset Management£50£500 (top up £100)YesInitial/Admin: Nil. Annual: Nil.
Martin Currie (through Alliance Trust Savings)£50£50YesInitial/Admin: Nil. Annual: £10 per quarter.
Scottish Investment Trust plc (Plan Manager: SIT Savings)£25£250YesInitial/Admin: Nil. Annual: Nil.
Witan Investment Services£50£250YesInitial/Admin: Nil. Annual: £31.60.

Source: The Association of Investment Companies, as at 3.11.16

 

Bare trusts

For many parents, the idea of their children accessing a hefty Isa pot at age 18 is a problem. But a bare trust is harder to access than a Jisa because even after the child turns 18 they have to request access from the trustees of the trust.

As with a Jisa, you can invest a bare trust in stocks, shares and funds, but there are no contribution limits. Your child will be taxed on the account if income or dividends exceed their allowances, however this is unlikely. The bare trust is administered by a parent or grandparent.

Hargreaves Lansdown offers a junior investment account, which is a fund and share account set up as a bare trust. Withdrawals can be made at any time as long as they are used for the benefit of the child and are free to set up. The fees are the same as on a Hargreaves Lansdown investment account - tiered within bands starting at 0.45 per cent on the first £250,000 of funds. There is no charge for holding shares, investment trusts, ETFs, gilts and bonds.

Trusts are also useful for inheritance tax (IHT) planning as gifts to trust can reduce the value of your estate, and therefore the amount of IHT your children have to pay in future.

Pros

■ Harder for child to access

■ No investment limit

■ IHT benefits

Cons

■ Not free of tax

 

Pension

A pension is the most tax-efficient way of saving for a child - you can save up to £3,600 a year into a pension for a newborn child from birth and only have to make a net investment of £2,880.

"The mega-attractive investment vehicle that most people forget about is a pension," says Jason Hollands, managing director at Tilney Bestinvest. "Your child cannot touch it until they retire, but by the time they do, with 18 years of your contributions they could end up with a million pounds in their pension without having to pay any money in themselves."

But because your child won't be able to access a pension until at least age 55 it cannot be used to pay for nearer-term costs such as university fees or a deposit for a first home.

Pros

■ Tax-efficient investing

■ Pension security for your child

Cons

■ Child cannot access until at least age 55

 

Cash savings options

If you are very nervous about losing money on the stock market, there are ways to potentially earn more on your money than just holding cash.

You could mix and match savings and investments, for example, with grandparents buying your children premium bonds and you putting some money into investments.

The problem with any cash component, however, is that it does not keep pace with inflation and if this is a significant part of your child's portfolio this could also be the case with the overall return.

 

Savings account

You can set up a bank or building society account on behalf of a child, which they can start managing themselves from the age of seven. While children's savings account rates are higher than most others, they have also been falling fast. The average interest rate on these is 1.39 per cent, down from 1.61 per cent in October 2015 and 1.54 per cent in October 2014.

One of the best rates available is the 4 per cent offered by the Saffron Building Society Children's Regular Saver 12-month bond.

The HSBC MySavings account, meanwhile, offers an annual equivalent rate (AER) of 2.72 per cent. But this is a variable rate - as is common with most children's savings accounts.

"Unfortunately as the majority of child savings accounts pay variable rates, they are in danger of rate changes at any moment, so it's worthwhile being diligent in checking the savings pot on a regular basis and not putting up with any paltry interest," warns Rachel Springall, finance expert at Moneyfacts.co.uk. "Some fixed regular savings accounts still offer considerably higher rates than alternative child savings accounts."

Pros

■ No stock market risk

■ Good way to teach your child about money

Cons

■ Risk of inflation erosion

 

Premium bonds

Premium bonds, which are issued by NS&I, are the UK's most popular savings product, with more than 21m people saving over £63bn into them. They are a good way to store money for your child, particularly if relatives want to buy your child a cash gift.

The main benefit of this product is that you can take the money out whenever you like, and you also benefit from the chance of winning a prize. You have to invest at least £100 to get started (or £50 if you agree to pay money in by standing order), and get a bond number for every £1 invested. So, for example, with £100 invested you theoretically have 100 chances of winning a premium.

A major benefit of premium bonds used to be that the premiums were paid tax-free, but the new personal savings allowance, whereby everybody is now able to earn £1,000 of interest a year on their savings tax free, has made that less of a lure.

Critics point to the fairly low prize rate of 1.25 per cent, which means your chances of winning are 30,000 to one. And you could win as little as £25. But Danny Cox, chartered financial planner at Hargreaves Lansdown, says: "With cash returns so poor, the potential for a tax-free prize compared to meagre or zero interest is attractive: even if your cash is paying nothing, with premium bonds you could win something. The absolute security premium bonds provide is of key importance to savers and investors alike, and as a birthday gift, premium bonds provide more than 210 monthly opportunities to win a prize over the course of a childhood."

Investment Quorum's Petronella West adds: "Saving for children involves having lots of small pots of money. So asking grandparents to buy children premium bonds for birthdays is a good way to start building up blocks of money."

Pros

■ No chance of capital loss

■ Chance of a prize

Cons

■ Relatively low chance of prize

■ Lower returns than the stock market

 

NS&I Children's Bonds

NS&I Children's Bonds are five-year renewable bonds designed for children under 16. They make a fixed-interest payment each year tax-free and the child gets control of the bond on their 16th birthday. Until that point, as with premium bonds, only a parent, guardian or grandparent can buy them for a child.

You can invest between £25 and £3,000 per bond issue, in £25 units. When there is a new issue of bonds, you can invest another £3,000 and when the five-year term is up, you can either cash them in, or reinvest for another five years at a new interest rate. The bonds will stop earning interest when they mature or the child turns 16.

But you will be penalised if you take money out of a children's bond early, so be prepared to leave it for five years. The rate on the most recent issue - 35 - is 2.50 per cent.

Pros

■ Fixed rate of return

■ No risk of capital loss

Cons

■ No early access without penalty

 

Savings products compared

ProductAccessTax-free returns?Type of return Maximum investment per year 
JisaAge 18 YesCapital growth and reinvested dividends£4,080
Investment trust savings scheme Your discretion NoCapital growth and reinvested dividendsNo limit
Bare trusts 18NoCapital growth and reinvested dividendsNo limit
Pension55YesCapital growth and reinvested dividends£2,880 (£3,600)
Premium bond16YesPotential for prizes£50,000
Savings accountAnytimeNoInterestNo limit
Children's bond16YesInterest£3,000 per issue

Source: Investors Chronicle