Earn 7.25% Interest On Your Children's Savings

The Child Trust Fund has just reached its third anniversary. How far has the initiative come in the last three years?

This article has already been emailed to Fools as part of our 'The Good, The Bad and The Ugly' campaign. As our 'The Good, The Bad and The Ugly' series continues, I'm going to talk about the `good' Child Trust Fund initiative, which has just celebrated its third anniversary. Before we look at how far child trust funds (CTFs) have come in the last three years, let's take a quick look at the basics. CTFs provide any child born after 1 September 2002 with a voucher from the Government worth £250 (£500 for lower income families), with a further top-up of the same amount when the child reaches the age of seven. The voucher is used by parents to open a CTF account, which is completely free of tax. You (and other members of the family or friends) can add extra contributions up to £1,200 each year, but your kids won't be able to get their hands on the money until they are 18. After this, the account is accessible to them, and they can choose to spend it or save it somewhere else. (Foolish teens would choose to move their CTFs to an ISA where it will continue to grow tax-free.) I like CTFs because, firstly, it's free money from the government! Secondly, they give your children a financial head start which I hope will encourage further saving for the future. It's just a shame those born before the cut off date miss out. If you're a new parent, you'll need to decide what to do with the CTF voucher when it arrives. But above all, it's vital you do something rather than nothing. While many parents have opened accounts, thousands of vouchers remain un-invested. This may seem distinctly un-Foolish but, given that the choice of CTFs on offer is bewildering, it is understandable. Be warned: if you still haven't invested the voucher after a year it will be done automatically and you'll lose the right to choose where your child's money goes. Of course you want to put the voucher to good use, but how do you go about doing that? Trust In Cash First of all you'll need to decide whether to invest it in cash or in shares. This largely depends on your attitude to risk. If you err on the side of caution, the safer option is to go for a cash-based CTF which avoids the thrills and spills of the stock market. Just make sure you choose one which pays a great rate of interest. To help you with that, take a look at these market leaders: Top Child Trust Funds - CashBank/Building Society Interest Rate Minimum Top-Up Introductory Bonus Hanley Economic BS 8.00% £1 None Britannia BS 7.25% £1 Rate inc. 1.25% bonus for 24 months Chorley & District BS 7.00% None None Yorkshire BS 6.80% None Rate inc. 0.70% bonus for 12 months Shepshed BS 6.50% £1 None Skipton BS 6.50% £10 None Source: Moneyfacts.co.uk You may have noticed the headline for this article highlights a return of 7.25% and not the higher figure of 8% as shown in the table. That's simply because a CTF from the Hanley Economic Building Society must be opened at one of their branches, which are only located in North Staffordshire and South Cheshire. If you're lucky enough to live in one of these areas, you have the opportunity to take advantage of a fantastic rate - so I recommend you do! For those of you who live in other parts of the country (and aren't prepared to travel to a Hanley Economic branch), Britannia Building Society is the next best bet. It offers a cash CTF which pays an impressive rate of 7.25%. Just watch out that the rate still matches up once the 1.25% bonus disappears after two years. Take A Risk So that's cash CTFs. But if you want to build up a nest egg for your child, then arguably the best way to do that is to invest in the stock market. Historic returns show us shares perform better than cash over the longer term but, of course, it's a gamble and there are no guarantees. If you're happy to take more risk, choose a `stakeholder' CTF where your child's money will be put into an investment fund which invests in shares. You won't hold any shares directly as a fund manager will choose stocks for you. 'Stakeholder' simply means the CTF meets a specified set of criteria, such as low charges (a maximum of 1.5% per year) and a minimum investment (£10 or less). The fund manager must also manage the investment risk by holding stocks across a range of companies and money must be moved gradually to lower risk assets once your child reaches 13 to protect the value of the CTF. Here's the pick of the stakeholder CTF bunch since launch. Top Stakeholder Child Trust Funds Over Three Years - SharesFund Name % Growth Since Launch Scottish Friendly Managed Growth 35.30% F&C FTSE All-Share Tracker 27.84% Legal & General UK Index Trust 27.55% L&G (N) Tracker Trust 25.71% Insight Investment Foundation Growth 24.22% Halifax UK FTSE 100 Index Tracking 21.80% Source: Investment Life and Pensions Moneyfacts/Lipper As you can see the top fund from Scottish Friendly has produced a return of 35% over three years which puts it firmly ahead of the best cash CTFs. But, on the other hand, the performance of stakeholder CTFs in the last year has been negative across the board as a result of poor stock market growth in general, so you must be willing to accept some volatility if you decide to go down this route. If you feel really adventurous, you could invest your child's voucher in a non-stakeholder CTF which gives you direct access to shares both in the UK and internationally. But, unlike Stakeholder CTFs, there is no charge cap and no process to protect the fund value as it nears maturity - unless you do it yourself. I hope this helps you to decide which type of CTF to go for. Once you've done that, you can top it up with £100 a month (or up to £1,200 each year), or as much as you can afford. That will give your child even more reason to celebrate on their 18th birthday! If you want to save more than £1,200 a year for your child, you can compare savings accounts with The Fool.