Eleven Million Children Lose Out

In 2020, the first tax-free Child Trust Funds will mature. Alas, most children don't have one, so here are ideas for saving and investing for kids.

All children born after 31 August 2002 are entitled to open a Child Trust Fund (CTF), which is a sort of tax haven for kids.

In order to encourage parents to save for their children, HM Revenue & Customs give each new baby a voucher worth £250 (£500 for low-income families), plus the same sum when s/he reaches the age of seven. Parents can put this voucher into their child's CTF and either save it in a deposit account, invest it a stock market-linked Stakeholder CTF account, or even buy shares in his/her name.

Of course, on its own, this initial gift wouldn't be worth very much: £250 growing at 5% a year in a tax-free CTF savings account would be worth just £602 after eighteen years -- and that's before taking inflation (rising prices) into account. However, the joy of a Child Trust Fund is that parents, grandparents, other relatives and friends can contribute up to £1,200 a year into this tax-free shelter, allowing a child to build up a substantial lump sum over time.

Sadly, children born before September 2002 aren't entitled to a CTF voucher; indeed, they can't have a CTF at all, which deprives them of a valuable tax haven. According to the Building Societies Association, between now and 2020, when the first CTFs start to mature, eleven million children will turn eighteen without a CTF fund to get them off to a good start in life. Even worse, a third of these children (3.7 million in total) will start adult life with little or nothing to their name, simply because their parents failed to save for them and didn't teach them to save. What a shame!

Of course, building societies make a huge contribution to teaching children good savings habits at an early age, and they account for almost two-fifths (38%) of the children's savings market. Indeed, along with millions of kids, my first introduction to saving came when my parents opened a building society account in my name. Alas, the savings habit didn't stick, so I only became a solid, sensible saver in my early thirties!

So, what can you do if, like me, you have a child who is too old to qualify for a Child Trust Fund? The answer is simple: you save or invest elsewhere and worry about the tax implications later!

Saving for children

Children don't have to pay tax on up to £100 of savings interest per tax year on capital given to them by a parent (so that's £200 from two parents). To earn more than £200 a year in interest, a child would need, say, £5,000 on deposit earning 4% a year, which is far more cash than most children own.

In order for your child's interest to be paid tax free, you need to complete and submit a form R85 at your local building society/bank branch. Note that interest earned on cash gifts received from anyone other than parents will usually fall well within a child's personal tax allowance, currently £5,035 for the 2006/07 tax year.

According to independent financial researcher Moneyfacts, these are the highest-paying non-CTF children's savings accounts on the high street:

Thus, if you want a branch-based, instant-access savings account for a child, I'd recommend the Smart account from Nationwide BS. Both of my children have one, so I'm happy to recommend it to other parents!

Investing for children

As I explained last week in Investing Advice From A Five Year Old, I've been looking around for a shares-based investment for my son. Because he's five, he's too old to have a CTF, plus he can't directly own shares in his name. Hence, I've decided to invest in a simple, ultra-low-cost index-tracking fund on his behalf, using what's known as a "designated account", which means I apply in my name but include his initial afterwards to show that he is the beneficial owner.

The UK's cheapest index-tracking fund is the Fidelity MoneyBuilder UK Index Fund, which charges a total expense ratio of just 0.3% a year to track the FTSE All-Share index. Hence, my little boy will soon be investing cheaply in the shares of around seven hundred of the UK's largest stock market-listed firms.

Finally, my wife has agreed to open Stakeholder pension plans for our son and daughter, into which she will pay £100 apiece. With automatic tax relief, this £100 immediately turns into £128.21, which is an excellent start. By setting up pensions for them, we can provide valuable financial support for our children when they reach 55 -- and long after we're both dead and gone! You can learn more about this approach here.

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Disclosure: Cliff owns shares in HBOS, parent company of Halifax and Bank of Scotland.