Savings and investments can be cool for kids

If your child was born before 1 September 2002 and missed out on the £250 Child Trust Fund from the government, don't despair there are plenty of other tax efficient savings schemes to choose from. The problem is you are spoilt for choice. There are cash deposit savings accounts, children's bonus bonds, friendly society bonds, stocks and shares, mini Cash Individual Savings Accounts (ISAs) - for those over the age of 16 - and stakeholder pensions to choose from.

Cash is great for short-term savings and to encourage the child to save but is not the best long-term performer. Every child has the same personal and capital gains tax allowance as an adult and as long as they are not earning more than £4,895, they won't pay any tax on the interest earned.

However, if a parent is funding the account, HM Revenue & Customs (HMRC) says that everything above the first £100 of interest should be subject to savings tax at the parent's rate of tax. This is to stop parents from salting away cash in their child's name to avoid paying tax. The big advantage is that interest is paid gross. You need to fill form R85 from HMRC to get this perk.

Children's cash accounts are run by an adult until the child is seven and after that they can be run by the child up until varying ages sometimes 16, 18 or even 21. Compared to adult savings accounts, the interest rates on kids' accounts can be quite attractive. Chelsea offers 4.8% on its Ready Steady Save account while Halifax pays 4.8% on its Save4it accounts for under 16s.

Many banks and building societies also offer higher rates if you pay in a regular amount or hand over your money for a set period. For example, Halifax pays 10% gross for a year on its Children's Regular Saver but you have to pay in between £10 and £100 a month. With Scarborough Building Society's Children's three-year savings bond, gross interest is 5.5%.

Children's bonus bonds from National Savings & Investments are tax-free government-backed investments and you can invest up to £3,000 for each child in each issue. They have to be managed by an adult until the child is 16 when they can take them over themselves. They are tax free and offer a bonus every five years until the child is 21. However, Anna Bowes, savings and investments manager of Chase de Vere Financial Solutions, comments, "While childrens bonus bonds are a safe bet, the interest rate of 3.85% is not very exciting. You just have to look at what you could get on a cash deposit account."

Adults can also save for their offspring in children's bonds from friendly societies. Basically, these are endowments - and we all know how these have faired over recent years - and, although tax-free, you have to make a regular payment over at least 10 years.

For long-term savings over five, 10 or even 18 years to pay for schooling or university, equities are often the best performers. Although some fund managers such as Baillie Gifford and Invesco offer children's investment funds, in fact you can use any investment fund you like. Parents or relations simply put the child's initials on the account holder's name. This sets the account up as a bare trust and once the child is 18 they can access the cash and use it as they please. If you want to set up a trust it is best to get independent financial advice.

The attractive things about these equity investments are that you can start them with £50 a month, even lower for the children's investment funds, you can put in money when you want to and the tax liability is based on the child's personal tax allowances not the parents.

Alternatively, you could simply save up in your own ISA. This gives you up to £7,000 tax free in a maxi stocks and shares ISA or £3,000 in a mini Cash ISA and £4,000 in a mini stocks and shares ISA a year. To do this you don't have to do anything special but as Anna Bowes points out it is advisable to have the amount earmarked for your youngsters clearly stated in your will otherwise should anything happen to you, it would go into your estate. When the money is handed over to the child, there is no inheritance tax to pay as long as the person making the gift lives more than seven years.

Stakeholder pensions are tax efficient and flexible - you can switch providers without paying fees and stop and start contributions as you like. You may invest up to £2,808 a year and the government will make it up to £3,600. When the child reaches 18, they take over the pension contributions. However, they would have to wait until they are 55 to get access to the cash - perhaps a little late for paying school or university fees!

21 March 2006 © Moneyextra.com

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Our senior editor Robin Amlôt recommends you should consider taking independent financial advice before acting on any article. Please contact us for help with your individual circumstances if any assistance is required.