Make The Most Of Your Child Trust Fund

Child Trust Funds are a great concept but don't be fooled into thinking they're all the same. Here we take a look at the options to help you build a bigger nest egg for your children.

Parents certainly appear to have caught on to the Child Trust Fund (CTF) concept with around three million accounts already up and running.  As the first children to benefit from CTFs reach their fifth birthday, it's an ideal time to consider all the options if you've just received your child's voucher. Here I'll take a look at low risk cash CTFs at one end of the spectrum up to highly speculative investment funds at the other. 

But first I'll briefly cover some of the basics: CTFs were launched back in April 2005 and entitle any child born after 1 September 2002 to receive a voucher from the Government worth £250, or £500 for lower income families, with a further top-up of the same amount when the child reaches seven. The voucher is used to open a CTF account which is completely tax-free.

Extra contributions up to a maximum of £1,200 can be made each year but your child won't be able to get their hands on the money until they reach eighteen. After this, the account closes and the accumulated fund becomes available. It can be moved to an ISA where it will continue to grow in a tax-efficient environment.

This is just a quick summary of CTFs but if you'd like to read more take a look at 10 Things To Know About Child Trust Funds.   

Not All CTFs Are The Same

CTFs are a simple initiative but they aren't all the same and fall into three broad categories:

•      A cash deposit account
•      A stakeholder equity (stocks and shares) based investment
•      A non-stakeholder equity based investment

I'll look at each of these options in turn. First up, cash accounts - these are the least risky form of CTF which earn interest tax-free. Here are the five most competitive accounts:

Top Five Child Trust Funds - Cash Accounts

Source: Moneyfacts. Accounts which permit investment from the local area only have been excluded

Looking at other children's savings accounts these rates are competitive but if you find the cash CTF you chose doesn't come up to scratch, you can transfer in and out of other cash CTFs without penalty.  Since your child's capital is secure, if you don't want to take any risk then this is the type you should go for.

To give you an idea of the possible return, if £1K is invested in a cash CTF at outset, assuming an interest rate of 7.50%, your child will end up with a nest egg of £3,675.80 when they reach eighteen.

But the usual rules of risk and reward apply. If you'd like something more adventurous with the potential for a greater return then the next step up is the stakeholder equity based CTF where the voucher is invested in a specific investment fund.

The term ‘stakeholder' means the CTF meets a minimum set of criteria set by the Government. This breaks down as follows:

•     The minimum investment is no greater than £10
•     The maximum annual charge is capped at 1.50% 
•     The CTF must invest in broadly based investment funds to help spread risk
•     The CTF must provide a ‘lifestyling' strategy *

* Lifestyling is a strategy which reduces exposure to shares when the child reaches thirteen. At this point money will gradually be moved into lower risk assets such as cash and gilts (bonds issued by the Government). This helps to protect the fund from any potential downturn in the stock market as maturity approaches.

The stakeholder criteria ensure the CTF is available on fair terms. But these minimum standards don't guarantee how it will perform. That depends entirely on the investment fund you choose.

There are currently twenty seven companies who offer this type of CTF and a third of these offer index tracking funds, including F&C, Halifax and Nationwide. (The remaining CTFs offer managed funds where the fund manager actively selects stocks). 

Index tracking funds invest in the shares of the companies quoted on a particular index. For example, a FTSE 100 tracker fund invests in all the top 100 companies quoted on the FTSE 100 index with the aim of replicating (or tracking) its performance. Regular readers will know we're pretty keen on index trackers here at The Fool.

In the last year the FTSE 100 has returned around 7.3%, so you would expect growth on a FTSE 100 index tracker CTF to be close to this figure. When you knock off management charges this may not seem so appealing relative to the best cash CTFs. But you shouldn't draw too many conclusions from short term performance. Over the last three years the FTSE 100 returned more than 50% and almost 70% over a five year period. You won't be able to get this kind of performance from a cash CTF. But on the other hand, there's no way of telling if the index will fare as well in the future.

What we can say is that over the longer-term equities have historically performed better than cash. If volatility doesn't worry you too much, you could go for something even more exciting. Non-stakeholder equity based CTFs provide greater investment freedom but they aren't for the faint hearted.

You will have to do your research to find the right CTF for your child. Remember if you don't invest the voucher -- and estimates suggest a quarter of parents still haven't -- after 12 months the Government will make the decision for you. 

More: Are Child Trust Funds Worth Investing In? | My Son The Millionaire