Join our community of smart investors

Nuts and bolts of Junior Isas

Hot on the heels of the now defunct child trust fund comes the government's latest children's savings initiative, the junior Isa, scheduled for launch on 1 November
October 26, 2011

Come 1 November 2011 parents will have a new children's savings option in the form of the junior individual savings account (Isa). The junior Isa will replace the child trust fund (CTF), another government-sponsored savings scheme, which closed for new applicants on 2 January this year. However, existing CTFs will continue to be run until their maturity - that is, when the child in whose name they were opened turns age 18.

If your child was born on or after 3 January 2011 or before 1 September 2002 and is under the age of 18, they would not have qualified for a CTF but you can now open a junior Isa for them. Also, if you have a child born between 1 September 2002 and 2 January 2011 and they did not qualify for a CTF, for example because the family was living abroad, you can take out a junior Isa if your child is now resident in the UK.

The junior Isa has a number of tax benefits: interest and income earned on investments held within the Isa do not incur income tax, and if an investment is sold within the junior Isa it will not incur capital gains tax (CGT). However, the investment limit on the junior Isa is much lower than on the adult Isa – no more than £3,600 a year can be paid into the wrapper, in contrast to the £10,680 total limit for adults for the 2011-12 tax year, which increases to £11,280 in the next tax year.

Anyone can make contributions into a junior Isa, not just parents. But only a parent or adult with legal parental responsibility can open and manage a junior Isa for a child.

There are two types of junior Isas: cash accounts or stocks-and-shares accounts that hold a variety of investments including funds and investments trusts.

Some providers, for example Hargreaves Lansdown and Fidelity, will also allow you to hold cash in reserve within a stocks-and-shares account for later investment - known as a 'cash park' or 'cash reserve account'.

"If you have less than five years to when you draw on the junior Isa, then a cash Isa is probably a good option," says Danny Cox, head of advice at Hargreaves Lansdown. "For a time horizon of more than five years you should consider a stocks-and-shares account, and one with a cash reserve facility would be useful so you can de-risk it in the last five years."

Alternately, each child can have a junior Isa of each type - cash and stocks-and-shares - provided the total of the investments put into these each tax year does not exceed the limit.

This is currently £3,600 but from April 2013 it will be raised each year in line with consumer prices index (CPI) inflation. You can also transfer to another junior Isa provider if you wish.

If you have set up two separate accounts for your child, for example one cash junior Isa and one stock- and-shares junior Isa, they do not necessarily have to be held with the same provider.

The child will not be able to access the money until the age of 18, although from 16 they can opt to become responsible for the account. Parents also do not have access to the money.

When the child turns 18, the account automatically converts into an adult Isa, which he or she can then access if they wish to.

If you move abroad after opening a junior Isa you cannot make payments into it, although the junior Isa will remain in place and continue to earn tax- free interest. If you return to the UK you can start paying into it again.

If you are employed by the Crown and work abroad, for example as a diplomat or in the armed forces, then you can open a junior Isa and continue contributing into it.

Child trust funds

The government will not make any payments into junior Isas. (With the CTF, the government gave all parents a voucher worth £250 (or £500 for less well off families) when a child was born, and a further one worth £250 (or £500) on the child's seventh birthday.)

The CTF had an annual investment limit of £1,200 which was considerably lower. Remaining CTFs will have their yearly limit raised to £3,600 to put them in line with the junior Isa, although no more government contributions will be paid into these.

If your child already has a CTF they cannot also take out a junior Isa, and you cannot transfer the CTF into a junior Isa. But you can still transfer to a different CTF provider.

How saving with a junior Isa adds up

Example 1: An investment in an investment trust vs cash (performance comparison of £1,000 lump sum)

10 years (£)18 years (£)
Average investment company*2,1303,400
FTSE All-Share (share price total return)1,5803,220
UK savings account1,2101,690

*Share price total return with a 3.5% deduction for charges

Source: The Association of Investment Companies (AIC)

Example 2: 5% growth a year on £1,117 investment

£1,117 yearly contribution (or £93 a month)*£34,000

*Assuming 5% yearly return gross of charges

Source: JPMorgan Asset Management

Example 3: Maxing out, with 5 per cent net growth annually

YearAmount (£)
13,600
27,380
311,349
415,516
519,892
624,487
729,311
834,377
939,696
1045,280
1151,144
1257,302
1363,767
1470,555
1577,683
1685,167
1793,025
18101,277
End 18th year£106,340

These projections are not adjusted for inflation and the value of investments and the income from them may fall as well as rise and be affected by changes in exchange rates.

Source: Fundsmith