Happy seventh birthday, Child Trust Funds
Tuesday, 01 September 2009 08:36
As Child Trust Funds turn seven this year, the first generation of savers will be entitled to another lump sum of £250 from the government.
With the costs of higher education rocketing, parents are being encouraged to start saving from day one. Even if higher education is not the right route, a lump sum at 18 to help children set themselves up for independence makes good sense.
The government's favoured way of saving for children is the CTF pushed as the best option.
Sarah Routledge asks if parents should be accepting the government line or looking into alternatives.
Child Trust Funds
The Child Trust Fund is a tax-free savings vehicle designed to give children a cash lump sum when they hit 18. Children born on or after 6 April 2005 will receive a £250 voucher from the government shortly after Child Benefit has been claimed and starts being paid, to start the fund off.
Children in families with lower incomes will automatically get an additional payment of £250 from the government.
Parents can then make their own contributions to the account, up to £1,200 a year. And a handy calculator can help you figure out how much you will need to contribute in order to reach your savings goal.
There are three types of account to choose from - savings, stakeholder or accounts that invest in shares.
Both shares and stakeholder accounts will attract a charge, while a savings account provider will include the running costs in the interest rate.
If you do not choose an account, the government will open a stakeholder account. These come with a capped annual charge, which is no more than 1.5 per cent, and automatically move the money to less risky assets, like cash, once the child reaches 13, a strategy called lifestyling.
Savings accounts are fairly straightforward, paying a rate of interest that will vary depending on who you open the account with.
Accounts that invest in shares will typically provide better returns - but as many parents have recently found out, a stock market crash can wipe out years of gains in a few weeks.
Given the publicity, and the fact that the government is offering cash to start the fund off, a CTF should be a popular way for parents to save for their child.
Yet figures from HM Revenues and Customs shows that since the CTF was introduced in January 2005, over a million new parents have failed to open their own account.
Independent financial adviser, Peter McGahan, says there are some good reasons for this reluctance.
"It's no surprise this idea has been met with considerable disinterest," Mr McGahan says.
"Its lack of success may be down to a couple of factors but most will be because of this one: At age 18 you do not know how your child will turn out. Will they be responsible with their cash or will they be wasteful?
"Someone saving £1,000 per year and with reasonable growth might expect their child to receive over £30,000 at age 18. Worse still, you have no control over what they will do with it and how they will be thinking. I suspect from an early age most will know they have a fund and could easily rely on that."
A lack of time and confusing information could be another reason new parents are not putting a CTF at the top of their 'to do' list.
Angela Watson, a new mother, describes her own experience of opening an account.
"I went for the Children's Mutual trust fund which I was 'introduced' to via Bounty (the baby website). To be honest, I didn't find it very easy to understand and just got the general sense that I was picking the medium risk option for investing Toby's bond.
"I think most people tend to go for the Children's Mutual because it's fairly simple, and I think everyone gets info about it with their Bounty packs (packs you get when you're in hospital)," she says.
There are still good reasons for making the most of your CTF, however, according to MyEggNest.co.uk spokesperson Kate Sackett.
"You can teach children about money and start to educate them about how their CTF is doing," explains Ms Sackett.
As children get older, you can encourage them to take an interest in how their savings are growing.
"Then, when they reach 16 they can decide how to manage it themselves," Ms Sackett added.
Although they will not be able to actually touch the money for another two years, this experience of managing a savings account could be very important, she says.
Financial advisers will tell you that shares will outperform cash in the long term, but, as everyone is now painfully aware, shares can go down as well as up and not everyone is comfortable investing someone else's money in this way.
It is difficult to compare funds that invest in shares as the returns can be volatile, but MyNestEgg has a set of comparison tables, which will give you an idea of past performance.
Alternatives
Tax Exempt Saving Plans
There is a little-known alternative - or addition to - CTFs, Tax Exempt Saving Plans (TESP).
These are long-term savings plans that are also completely free of tax, which can be set up for children.
But have the added flexibility of maturing earlier, or later, than the age 18 deadline set by the government.
And there is another benefit over CTFs: they are always within parental control.
So if you are a little worried your child may decide to blow your hard-saved cash on something other than university fees, these plans may be worth looking into.
TESPs are only available from Friendly Societies, and are for regular saving over a period of between ten and 25 years.
The maximum the government will currently allow is £25 a month, and the money can be taken from your account by direct debit, or even straight from your pay.
They also only invest in stocks and shares, so there is no option of a savings account paying interest, as with a CTF.
Children's stakeholder pensions
The government will now let you save for your child's future in a stakeholder pension scheme. Family or friends can save up to £2,808 each year on the child's behalf, with the Inland Revenue adding 22 per cent basic rate tax relief, bringing the total to a maximum of £3,600.
This has the benefit of providing some security for retirement and given that it is locked up until retirement, parents can feel more confident it will not be squandered on something frivolous.
But the main reason for starting a pension for a newborn is the early contributions will grow into a sizeable pot over the 60 years or so they are invested.
Simply by investing Child Benefit payments into a stakeholder pension until the age of 16 would create a fund of £128,000 by the time the child hits 65, based on. a projection from Legal & General.
Not a bad return for a small investment. Of course, the downside is children are likely to need the money before they reach retirement and when they are struggling for a deposit for a house or through university, they may not thank you for your foresight.
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