Now the Child Trust Fund has been killed off, current and future parents might wonder what the alternatives are. Could a new tax-efficient ISA be the way to go asks Iona Bain?
Torn up in the coalition agreement, the Child Trust Fund (CTF) was well-intentioned but had limitations for ambitious savers. The annual contribution was limited to £1,200 by the last government, who introduced the scheme in 2002. It also had the unhappy outcome of excluding some six million kids who were born before the scheme was introduced.
But now the CTF has been killed off, current and future parents might wonder what the alternatives are. Could a new tax-efficient fund be the way to go?
Many in the investment industry have long asked why children can’t have their own tax-efficient savings system equivalent to an adult ISA, especially when they don’t earn anything. Unless they are cutting it as a Hollywood child actor, of course.
This presented the government with an opportunity to start anew. Extending the ISA system to the under 16s would shed some of the bureaucratic burden and also save half a billion pounds in contribution costs – no small amount in these Spartan times.
The Treasury has now unveiled the Junior ISA, embracing all those who don’t have or weren’t eligible for a CTF. It will be available from 1 November 2011, with banks, building societies and other providers of standard ISAs all set to offer the product.
It places all the responsibility on the parent or guardian to open the account and use it. But the annual contribution limit will be £3,600 – indexed to consumer price inflation from April 2013 – a dramatic increase in the ceiling. Like the CTF, the savings will be locked in until the child turns 18. When that day comes, the Junior ISA will become an adult version automatically. However, children will have the right to manage their account from the age of 16.
The previous CTFs will continue for existing holders, including those children born up to January this year, but the government will no longer make a contribution of £250 at birth and at the age of seven, like the original CTFs (for poorer families, the contribution could be £500 both times). Also, those that still have a CTF cannot have a Junior ISA as well. On the plus side, they will have their annual contribution limits brought in line with those who have an ISA - a rise from £1,200 to £3,600 upwards.
Clearly, the Junior ISA won’t reach out to those poorer families struggling to save and who need a financial incentive from the state to put money away. It only gives a boost to parents who are proactive and savvy savers. They may already be a dab hand with adult ISAs and therefore have the confidence – and patience – to invest in stocks and shares over a long period for their children.
Contributions can be split between one cash and one stocks and shares Junior ISA. But if parents choose to invest the Junior ISA in stocks and shares rather than cash, all the evidence suggests that fortune favours the brave. Yes, the safer cash investment may be be seen as a prudent choice for parents of teenagers, since there is a greater risk of loss if you enter into stocks and shares for five years or less. But cash is not performing well in the current climate and a stocks and shares Junior ISA could be a good option for an investment lasting 15 years or longer, or if your children are still crawling on all fours.
It could certainly be preferable to the lousy rates currently associated with children’s savings accounts. Recent research from Which? suggested half of all children’s accounts offer a rate below 1%. Moreover, the rates on CTFs (far from spectacular at the moment) will almost certainly wither on the vine as providers concentrate on capturing a new market for the Junior ISA. Whether or not the government will in time allow existing CTFs to merge into new Junior ISAs is unclear.
But if parents aren’t satisfied with the Junior ISA route, there have always been other options available. There has been nothing stopping parents from using ordinary ISAs to help their next of kin. After all, the annual limit here is now £10,680.
In an ordinary savings account, interest exceeding £100 on any amount deposited by the parents will attract tax at the parent's tax rate. But if the account is funded by a grandparent or other generous relative, interest up to the child's personal tax allowance - this year a huge £7,475 - can be salted away tax-free.
Besides this, an investment trust share plan has always been a popular and trusted way to go. You have the option of retaining complete control by having the plan in your name, or you can open a designated account on behalf of your child, which would allow you to maintain responsibility and gain access to the fund whenever you need to.
The annual charges in many popular investment trust plans are often below 1.5% - which is what many CTFs ended up charging as it was the maximum amount allowed. You will still be subject to taxation on dividends however, 10% for a basic rate taxpayer or 32.5% for a higher rate taxpayer.
But there could be a lot more on offer when it comes to Junior ISAs. The Association of Investment Companies has welcomed the decision to allow providers to decide what type of product they want to offer - rather than forcing everyone in the market to offer a cash CTF. It says the new regime “should encourage more providers to enter the market which in the long term will deliver opportunities for lower cost, better performing investment”.
Whether a CTF or a Junior ISA, one issue remains to trouble some parents; what will a young person do when a potentially sizeable sum is presented to them on their 18th birthday? Those parents who choose an investment trust plan in their own name may not have as much cause for concern.
Find out more about Baillie Gifford's Children's Savings Plan.
Please remember that, as with all stock market investments, the value of your investment can go down as well as up and you may not get back the amount originally invested.
Past performance is not a guide to future performance.
Current tax rates and reliefs and the tax treatment of ISAs may change. The value of any tax benefits will depend on investors' individual circumstances.
Investment trusts are listed UK companies and are not authorised or regulated by the Financial Services Authority.
Author: Iona Bain
Iona Bain is a young Scottish journalist who writes about personal finance matters for children and young people. She began writing Iona’s Young Money Blog in 2011, the first of its kind in the UK, after taking an intense interest in the financial issues affecting the younger generation, particularly since the recession took hold. Iona now writes for We Know Money, a new collection of websites being developed by moneysupermarket.com. She has previously been published in The Herald and Daily Telegraph.