Savings and investments for children - by independent financial adviser John Bramwell

Savings and Investments for Children

What is available?

There are basically two general areas of savings and investments for children. Firstly, there are savings and deposit type accounts where the children may have access to the funds themselves from an early age, eg. 8 years. These are typically used to save for special purchases, to show a child the benefits of saving and to give them experience of running an account.

Secondly, there are longer-term investments where access by the child may be restricted until they are 18. These are intended to provide more substantial amounts, eg. to help with further education or to buy a car. All types of savings and investments have tax implications.

Are taxes paid on children's savings?

Due to age restrictions, adults have to control accounts and investments for children. Before opening an account or making an investment for children, parents should consider the tax implications.

Children have their own tax allowances. However, any income that is derived from assets given to them by their mother or father is normally taxed as that parent's income. HMRC does not tax the income if it does not exceed £100 per year in respect of each parent separately. In general, parental and non-parental money should be kept separately.

If children are non-taxpayers, the savings and investments can be registered for payment of income without deduction of tax.

What types of short-term investments are available?

The following investments are primarily designed for short term savings with varying degrees of accessibility. All are considered to be low risk.

Children's bank and building society accounts - are popular as they have good rates of interest and are geared to be attractive to children. Some accounts have limits on how much can be placed in them.

National Savings & Investments (NS&I) - have several savings products, including Investment Accounts, Certificates, Children's Bonds and Premium Bonds. See NS&I.

Cash Individual Savings Accounts (cash ISAs) - can be opened each financial year by anyone aged 16 or over. See ISAs and PEPs.

What types of longer-term investments are available?

There are many other investments for children that are intended to be used for the longer term. These have increased volatility and a higher level of risk, but also have a higher likelihood of outperforming lower risk products and beating inflation. Over the long term the effect of the volatility becomes less significant compared to the overall return.

Collective funds, eg. investment bonds, unit trusts and investment trusts - are suitable for medium to long term investments. Generally these have exposure to stocks and shares to give a greater chance of better growth over the long term. There is a large range of these funds that can be held for a child, and a few are specifically targeted at children, although these are not often among the best performing funds available. See Collective Funds.

Stakeholder pensions - These pensions can be taken out for children. The maximum amount that can be invested is £2,880 per year but this is topped-up to £3,600 per year by the Government, as tax relief at the basic rate is given automatically, even though income tax may not have been paid.

This tax relief is a major advantage when compared to other children’s investments, as it means that all contributions immediately receive a 20% return on the amount invested. This is a very generous return and, when combined with the benefit of rolled-up growth over the long term, can provide a substantial pension fund.

The major disadvantage is of course that the child cannot receive benefits from the pension fund until retirement age.

If the maximum contribution allowed was invested each year for the first 18 years of a child's life, and then left until retirement at age 65, it has been estimated that the fund could be of sufficient size that further contributions to a pension may not be necessary. See Stakeholder Pensions.

Friendly Society accounts and bonds - have been popular in the past for both short-term savings and longer-term investment, due to their special tax treatment. Unfortunately the preferential tax treatment only applies to savings of £25 per month and accounts have relatively high charges.

Shares - Direct holding of shares is considered to be a high risk investment and is not recommended for anyone unless it is part of a large diversified portfolio, eg. greater than £100,000. Shares are therefore not generally suitable for children.

Should I put assets in trust for my children?

To ensure that assets gifted to children become the property of the child in the desired way, and at an appropriate age, it is wise to place them in trust.

This is quite simple to do in most cases, but there are many types of trust available and advice should be sought on which is the most appropriate, as part of general financial planning. Trusts are particularly important for Inheritance Tax (IHT) planning purposes.