What’s the best way to save for your children?

Many parents start a savings account for their children, which is great for showing them the basics of finance, but unfortunately, it is not the best strategy to build a nest egg for their future. The first reason is that any interest over £100 earned on money given to children under the age of 18 by a parent will be taxed.

The parent will have to pay tax on all the interest if it’s above their own Personal Savings Allowance (NB this is not the case with grandparents). It’s to ensure that parents don’t use their offspring to avoid paying tax.

On top of this, interest rates are currently at an all-time low, but even in more ‘normal’ times, cash savings do not always keep pace with inflation over the longer term, so while the value of your savings will gradually increase during your child’s lifetime, what this money can actually buy is likely to diminish.

From Child Trust Funds to Junior ISAs

To incentivise parents to save for their children, an initiative called the Child Trust Fund (CTF) was launched by the previous Government.  This tax-efficient savings scheme was open to every child born after 1^st September 2002, but it was ended on 2^nd January 2011. The scheme was largely unsuccessful, mostly because CTFs were costly for banks and investment companies to manage so most chose not to offer the product. Those that did, did not compete particularly hard on price, performance or service! Unfortunately, this has meant that thousands of children’s savings schemes are now languishing in costly and badly performing funds, with few other options available to them.

Children born either before or after the ‘CTF-years’ are eligible for a Junior ISA (JISA). Rather like the adult version, JISAs can be either cash-based or linked to investments in the stock market. Which one you choose for your child will depend largely on how long you plan to keep the investment and how open you are to taking investment risk.  The maximum contribution to a JISA for the 2016/2017 tax year is £4,080, and since April 2015 CTFs can be transferred to JISAs. Finally!

Hands off the cash!

One potential concern of both CTFs and JISAs is that the child will have unlimited access to the funds when he or she reaches 18. Some parents don’t like the idea of giving too much money to their children at such a young age — what if they’re just not ready for it?

An alternative could be to set aside some of your own savings for your children but keep them in your own name. The savings can then be gifted to your adult children at a time you feel is appropriate, but remember that there could be inheritance tax issues to be considered with this approach.

You could also set up a pension plan for your child, with a maximum annual contribution of £3,600. Although your child would not be able to access these funds until they were at least 55, any parental contributions are subject to tax relief so, for example, a monthly contribution of £100 would actually mean that £125 gets invested.

Retirement may seem like the long and distant future if your child is still in nappies, but saving for retirement is likely to be a huge concern for the next generation. Your forward planning in helping them start to address this issue very early on will surely be fully appreciated in the years to come!

Ian Thomas is authorised and regulated by the FCA. This article is intended to provide helpful information of a general nature and does not constitute financial advice.

Article is accurate at date of writing.