Child Trust Funds set for next payment

Now could be a good time to switch, with a stock market recovery predicted this year or next. Even if you have been sheltering your child's nest egg in cash, it could be worth considering taking a bit of a risk right now, as children getting their second lump sum from the government still have 11 years to run with their account.

Look at fund performance, or whether you are getting a competitive interest rate and accept that you may have different, perhaps more conservative, sentiments about your child's nest egg to your own investments.

Launched in January 2005 (when the first government vouchers were issued), the CTF scheme aims to provide every child born in the UK since 1 September 2002 with a nest egg that will mature when they reach 18. Each eligible newborn child receives £250 from the government when their parents register for child benefit. The government will make a second contribution of £250 when the child is seven and is considering a third in the child's teenage years. Parents, family and friends can contribute up to £1,200 each year. The fund grows free of tax until the child is 18 and can withdraw it as a lump sum or roll it over into an individual savings account (Isa).

While parents make their own investment choices for the fund (the child can become involved at age 16), the government's preferred investment option is a Stakeholder Child Trust Fund Account. All Stakeholder CTF accounts are subject to strict guidelines governing investment type and charges.

David White, chief executive of The Children's Mutual, says: "Making the step into adulthood is often a strain financially. But from 2020 all 18 year-olds will be receiving their child trust fund and those whose families have managed to save the maximum amount of £1,200 each year will have a fund that could be worth £37,100 upon maturity. Those who save the average amount amongst our customers of £24 a month could have a fund worth £9,750 when they reach age 18."

The £37,100 future projected value is based on investing £100 a month (excluding the government's initial £250 voucher and another £250 at age seven) for 18 years in a stakeholder CTF account, with yearly growth of 7 per cent and charges of 1.5 per cent of the account's value each year.

The £9,750 future projected value is based on investing £24 a month (plus the government's initial £250 voucher and another £250 at age seven) for 18 years in a stakeholder CTF account. It assumes an investment return of 7 per cent a year, and charges of 1.5 per cent of the CTF account value each year.

There is much debate as to whether the child trust fund should be the preferred means of saving for children. Some independent financial advisers (IFAs) advocate that if you're not fully subscribed to Isas yet, you should use these first as you will have greater control over how the money is spent.

You may also be able to achieve more investment flexibility outside a CTF by setting up a fund or share dealing account as a bare trust on behalf of a child.

CTF INVESTMENT OPTIONS

There are three types of the tax-free account: investment and stakeholder CTFs invest the money in stocks and shares, while ordinary savings accounts are for cash deposits. Parents can choose which account they put their money into, with the government automatically putting the cash into a stakeholder account if parents don't act within 12 months of their baby's birth.

Stakeholder accounts tend to initially offer exposure to the stock market through FTSE tracker or balanced funds and then, when the child reaches 13, they gradually move into safer investments such as cash and bonds. The theory is that you get the benefit of stock market investment and then lock-in the gains.

Equity accounts offered by stockbrokers and City fund managers such as F&C do not have this lifestyling element, so are higher risk, while cash accounts offer more security but are likely to produce lower returns over the long term.

Saying this, research from Moneyfacts reveals that cash CTFs have delivered superior returns to stakeholder accounts since the scheme was launched.

The survey examined the performance of cash and stakeholder CTFs in each tax year since April 2005. It found that despite enjoying strong investment returns in the first two years, the average stakeholder CTF is now worth a quarter less than the average cash CTF.

Notes: table shows fund performance for every tax year since the Child Trust Fund was launched in April 2005 and four year cumulative performance. Source: Lipper/Moneyfacts

Richard Eagling, editor of Investment Life & Pensions Moneyfacts says: "Whilst no-one would advocate investing in a cash CTF over the full 18 years, these figures demonstrate the important role it can play as a temporary safe haven during periods of market volatility. Although the stock market turmoil has meant disappointing returns for stakeholder accounts so far, the long-term nature of the child trust fund should ensure there is plenty of time for a recovery. Indeed, there are signs that their performance is starting to improve, with stakeholder funds up 8 per cent already this tax year."

However, you do have to watch the rates on cash CTFs. For example, in May 2009 Abbey closed its cash CTF to new savers. The bank has since dropped the rate to just 0.25 per cent for those remaining in the account or to 0.75 per cent if parents or other adults have raised a fund's balance to £750 or more.

Parents who have this cash-based Abbey Child Trust Fund should switch to a better deal. The best CTF cash rate is 5 per cent from Hanley Economic Building Society. However, this is a branch operated account only available to people in the local North Staffordshire catchment area. Yorkshire Building Society (the next best CTF offering) offers 3 per cent, which then drops to 2.3 per cent after one year. While this compares quite favourably to other easy access savings accounts, it doesn't knock your socks off and you're going to have to find another home for your CTF when the bonus expires next year.

CHILDREN'S DREAMS (costs today)

Source: The Children's Mutual