The arrival of a new baby is a time of great excitement. For the parents there is also a sense of responsibility. You want to make sure that your child’s financial needs (as well as their emotional needs) are taken care of. Perhaps you envisage them going to college one day and want to make sure that they won’t find themselves saddled with debt, or maybe you just want to give them the best possible chance of getting onto the property ladder. Therefore, when the initial chaos of nappy changes, frequent feeds, and disrupted sleep has been mastered, it’s common for parents to turn their attention to opening a savings or investment scheme for their child.
In the UK, a Child Trust Fund (CTF) provides a mechanism for parents to cater for their child’s long-term savings needs. The scheme was introduced by the Labour government in 2005 and offers the dual incentives of tax-free returns plus lump sum contributions by the government to get you started.
Child Trust Funds are available to all children born after the 1st of September 2002 and the basic key features of the scheme are:
The government provides a voucher for 250 pounds into the account when it is opened. Families on income support receive an extra 250 pounds (so 500 pounds in total). Government provides an additional 250 pounds (or 500 pounds for families on income support) when the child reaches the age of seven. All returns are tax-free Parents (and other relatives) can pay in up to 1,200 pounds per year. The account belongs to the child (rather than the parent) The money can’t be accessed until the child reaches the age of 18
That makes for a pretty attractive proposition but parents also have a choice of how they want the money to be invested. These options are:
CTF Savings Account:
Savings accounts provide a low risk means of accumulating money for your child. The main benefit of opting for the CTF Savings Account is you know that you are going to accumulate a sizeable fund without being at the mercy of the vagaries of the stock market.
CTF Stakeholder Shares Scheme:
An alternative to the Savings Account is to invest in shares. As with the CTF Savings Account, the government commits to provide money when the account is opened and again when the child turns seven, and the same 1,200 pounds annual investment threshold applies.
However, rather than the money being invested in a no-frills savings account, it will instead by invested across a range of equities. The main benefit of this is that historically the stock market has outperformed savings accounts in terms of long-term returns. Of course, there is more risk attached to investing in shares but the Stakeholder scheme looks to mitigate this risk in two ways:
Rather than money being invested in one company, it is invested across a range of companies. If one performs poorly or goes bust, then hopefully the performance of the others will compensate for this. Once the child reaches the age of 13, the funds are moved from equities into lower risk investments such as cash. This prevents a scenario where the stock market crashes just before the child reaches 18, destroying all the value that has been built up over the lifetime of the scheme.
There will be a charge for the running of the Stakeholder scheme but this is guaranteed to not exceed 1.5% a year.
Non Stakeholder Shares Scheme:
For those who believe that the stock market offers the best opportunity for wealth creation, the Stakeholder Shares Scheme may feel too cautious. The fact that the funds are transferred to less risky investment classes when the child turns 13, means that you only have 13 years to benefit from growth in the stock market rather than the full 18 years.
Therefore, some parents may wish to opt for a shares scheme that has none of the Stockholder risk minimisation safeguards. Your money will again by invested across a range of companies but the stock market investment will last for the full 18 years. Additionally, management fees are not capped, unlike with the Stakeholder Shares Scheme.
Summary:
Investing for your kid’s future is important and the attractive thing out Child Trust Funds is that the government will also pay money into the account and will allow you to receive the returns free of tax. That certainly sounds like a couple of compelling reasons to take advantage of the Child Trust Fund scheme.
Finally, it’s worth stressing that if you fail to invest the government voucher within one year of issue, then the government will automatically open the Stakeholder CTF on your child’s behalf.
Sources:
http://www.childtrustfund.gov.uk/
http://www.timesonline.co.uk/tol/money/reader_guides /article3359384.ece
http://en.wikipedia.org/wiki/Child_Trust_Fund#Stakeh older_account