The different ways to save or invest for a child
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Savings & Deposit accounts
You can open a children’s savings account with a bank or building society on the high street or using the internet. These are often child-friendly accounts which may come armed with cuddly toys and piggy banks to tempt you in. There is a vast array of deposit accounts available offering surprisingly different interest rates. Check the rate of interest being paid against the competition – you can use the press or the internet for comparisons. You may be better off taking an ordinary savings account and foregoing the free children’s toys.
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Also, don’t forget to fill in an HM Revenue & Customs form to enable your child to receive interest free of tax – you can get one from the bank or building society.
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Deposit accounts are simple to understand and offer easy access to the money held. Some accounts pay higher rates of interest if you, or the child as the account holder, are prepared to give notice before making a withdrawal, or agree to make only a limited number of withdrawals each year. The risk to your child’s savings is minimal if you choose a UK bank or building society and save in sterling. However, your savings may be eroded by the effects of inflation, which can be significant over time, if the money is left untouched for many years.
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National Savings
Products offered by National Savings & Investments are backed by the Government and are mostly tax-free. The returns from them, on the other hand, will never be that dazzling.
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Children’s Bonus Bonds can be bought for children aged under 16. The minimum investment is £25 and the maximum, £3,000 per bond issue. The money remains invested for five years and the bonds receive a fixed rate of interest for the term, plus a guaranteed bonus.
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Premium Bonds are also a popular gift for children. A monthly draw awards prizes to holders of Premium Bonds, including two £1 million prizes and numerous other prizes ranging from £50 to £100,000. The minimum investment is £100 and the maximum, £30,000. The rate of return depends on your Bonds being drawn each month, but if you held the maximum amount you could expect a nominal return of around 3 per cent each year, free of tax. (Source: National Savings & Investments, August 2008.)
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Friendly Societies
Friendly Societies are life assurance businesses which are mutually owned by their customers. They offer tax-free savings plans, which can be taken out by parents or grandparents on behalf of children. You are allowed to pay in up to £25 per month for a period of 10 years free of tax, usually investing in the society’s with-profits fund which can hold a range of assets including stocks and shares, bonds and property.
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While the investment remains tax-free, if you cash in before the end of the term (usually 10 years), you may suffer a penalty for leaving early. In some cases, you may not even get back what you have put in.
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Furthermore, although the tax-friendly status of these plans is their major draw, they can be costly compared to other forms of stock market investing and returns from them may be disappointing.
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Pensions
Since 2001, it has been possible to take out a pension for a child. You can also attract tax relief on pension fund contributions, even if you are not a taxpayer, and this means that pensions may be particularly suitable for children’s investments. You can currently save up to £3,600 gross in a child’s pension each year – costing you just £2,880 net to which tax relief is added by the Government.
Pension funds can be invested in stocks and shares but can also invest in other assets such as cash, bonds and property. And with a self-invested personal pension (SIPP) you can select where your money is invested. Pensions are inflexible, however, as the money will be tied up until the child reaches age 55.
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Shares and pooled funds
Although children cannot hold shares in their own name until age 18 (16 in Scotland), you can buy shares and hold them on behalf of a child. Many people shy away from this method of investing for a child because stocks and shares – also known as equities – carry a higher risk than cash and few know where to begin when it comes to selection. While it is possible to make good returns from well-chosen investments, it is also entirely possible to lose money if the stock market does badly or the company whose shares you have bought does not perform well.
You can buy shares through a stockbroker who will normally charge you commission. Deciding which shares to buy requires a lot of careful research and an excellent knowledge of the different industries in which they operate. Getting this right is a big job in its own right.
Alternatively, you can gain access to a wide range of shares and reduce risk by choosing a pooled fund such as an investment trust, unit trust or open-ended investment company (OEIC), all of which allow you to spread your money over a large number of company shares. This reduces risk as investing in, say, 50 companies will probably be less risky than investing in one. A pooled fund also allows you to share the costs of professional fund management with other investors.
There are many hundreds of investment trusts, unit trusts and OEICs on offer from a large number of investment managers, offering funds specialising in worldwide investments or any number of different geographical locations or industry sectors.
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Individual Savings Accounts (ISAs)
Investment managers often offer individual savings accounts (ISAs), which are tax-efficient accounts and which can hold pooled funds. You can invest up to £7,200 in an ISA in the 2008/09 tax year – a more generous limit than the £1,200 per year you are currently allowed to save in the Government’s Child Trust Fund. Children are not allowed to hold ISAs in their own name, however, so you would have to use your own ISA allowance for this.
ISAs have the added benefit of remaining in your control indefinitely. You decide when and how your children receive the funds invested in them but they should be regarded as a long-term investment as stock market values can fluctuate in the short term.
You should also note that, if you want to hold an investment for a child within a manager’s wrapper such as an ISA, there may be an additional annual administrative charge.
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Children’s investment plans
Some investment managers offer children’s investment plans featuring a selection of investment trusts and/or funds. You can usually invest lump sums from as little as £250 or monthly amounts as low as £30. These plans usually allow you to choose between designating the investment in the name of the child or setting up a bare trust to hold the investment on the child’s behalf until he or she reaches a certain age. These options are explained in more detail under ‘How to invest for a child and the tax implications’.
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