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Savings & Investments for Children

Many children are not eligible for a Child Trust Fund CTF. However there are many alternatives including Childrens Bonus Bonds, Friendly Society bonds, stakeholder pensions, savings accounts and stock market investments.

What's the tax situation with kids money?

Every child has its own personal tax allowance which is the same as that of an adult meaning your child will not pay tax on the first £5035 of income and the first £8800 of capital gains in the current tax year 2006-07.

However if you open any investment or savings account for your child be aware that whatever you decide to do if you as the parent give the money only the first £100 of interest earned or income received each year is deemed to belong to the child. Above that amount the income is taxable against parental earnings at your marginal highest rate of tax. This rule is designed to stop people avoiding tax by simply loading money into accounts for their children.

In addition to their tax allowances certain tax-free and tax-efficient investment and savings vehicles are specifically available for children including Child Trust Funds CTFs Friendly Society Bonds both confusingly referred to colloquially as Baby Bonds and Childrens Bonus Bonds.

Your child may have a stakeholder pension plan from birth contributing up to £2808 a year which with tax relief adds up to £3600 invested but is excluded from taking out a tax-efficient Individual Savings Account ISA until the age of 16 when they may save through a mini Cash ISA. Full ISA investment is only available from the age of 18.

How does the Child Trust Fund work?

It is a tax-free savingsinvestment vehicle available to children born on or after 1 September 2002. Your child is eligible if Child Benefit has been awarded for them and they are living in the UK.

The government offers a starting voucher for the CTF of £250 and another £250 voucher on your childs seventh birthday. Parents family and friends may contribute up to a total of £1200 a year into the account.

There is no access to the money in the CTF until your child is 18. The account and the funds contained in it are your childs property although it is managed by a person with parental responsibility until the child reaches the age of 16. Thereafter children will manage their own CTF accounts.

When your child turns 18 they will be able to withdraw the money and at that point he or she is entirely responsible for what happens to it. Read our guide to Child Trust Funds to learn more.

What if my child isn't eligible for a CTF?

Parents with children who do not qualify for the Child Trust Fund because they were born before September 2002 should certainly be looking for alternative financial solutions.

The CTF is essentially a trust wrapper to hold investments expressly for a particular child. This means that the nearest equivalent structure would be an absolute or bare trust arrangement which would allow the child access to the investment at age 18. Another alternative is to use some or all of either parents remaining ISA allowance where you can still maintain control over when and for what purpose the proceeds are used.

One of the differences between using an absolute trust and the new CTF is tax efficiency. The CTF has similar tax benefits to an ISA where there will be no tax implications for the person who donates the money. But where a parent provides the money to invest in an absolute trust for their child and the income exceeds £100 a year gross all of the income will be assessed for tax as if it belonged to the parent.

The rules concerning trusts can be extremely complicated even for absolute trusts the simplest of them. If you are considering setting a trust up you should talk to your independent financial adviser or solicitor who will be able to explain them to you.

What are Childrens Bonus Bonds?

Childrens Bonus Bonds are tax-free investments available from National Savings & Investments NS&I. There is a limit of £3000 on investment in each issue of bonds. Held in the name of the child under the control of a parent or guardian until the child is 16 the bonds can be opened with as little as £25.

Childrens Bonus Bonds were introduced in 1991 initially with an investment limit of £1000. The bonds are backed by HM Treasury and offer guaranteed interest rates when held for five years. They are tax-free; even if children become taxpayers and there is no tax for parents to pay. A bonus is payable every five years with a final bonus on the childs 21st birthday.

A new Issue becomes available whenever NS&I changes the interest rate on Childrens Bonus Bonds - roughly four times a year. Each Bond earns a fixed rate of interest for five years and on the fifth anniversary a bonus is added. The bonus is fixed when customers apply for the Bond so when they invest they know exactly what the Bond will be worth at the end of the five year term.

For example an investment of £3000 in Childrens Bonus Bond Issue 27 would earn compound interest of 2.25 per annum for the first five years £351.90. On the fifth anniversary the investment earns an 8.48 bonus of the original investment value £254.40. After five years the initial £3000 investment would be worth £3606.30 equivalent to an annualised return of 3.75 AER gross.

At the end of each five-year term holders may leave the Bond to earn a new tax-free rate of interest for a further five years or until the child is 21 when a final bonus is added.

What about Friendly Society Bonds?

Friendly Society Bonds are tax-free but have low maximum investments. If you attempt to cash them in early you are likely to get back less than you paid in.

You may pay in as little as £100 a year up to a maximum of £270 a year in lump sums or between £10 and £25 a month tax-free. These bonds have a minimum savings period of 10 years and typically invest in with-profits funds that pay annual bonuses.

Each child has a tax-free Friendly Society allowance of £270 a year. Most Friendly Societies offer child-specific 10-year investments in either with-profits or managed-fund investments or for longer to coincide with a special birthday such as 18 or 21.

The Bond is tax-free. This means free from income and capital gains taxes. The fund receives UK dividend income net of corporation tax which is not reclaimable.

What about ordinary savings accounts?

If you are opening a bank or building society account on behalf of a child you should complete an Inland Revenue & Customs form R85. Doing so will mean that no tax will be deducted from the interest earned on funds in the account. Many banks and building societies offer special accounts for children. These accounts obviously have age restrictions. Many may be opened with a deposit of as little as £1. Conditions and interest rates vary according to the amount saved and the term.

Ordinary savings and Investment accounts from NS&I may be opened for a child from birth at the Post Office. They pay interest gross and the liability to tax is against the childs annual allowance only. The account like all bank accounts may be controlled by the child themselves from the age of seven.

While your child may not have a cheque-guarantee card until the age of 18 some banks offer account access through cash cards.

Can my child invest in the stock market?

There is nothing to stop you arranging equity-based investments for your children. Some fund managers even offer products aimed at children. However branding an investment vehicle as specifically for children is no guarantee of investment success and you should remember to compare these funds alongside others that are not obviously marketed to the younger investor for performance purposes.

Remember that with any stock market linked investment the capital is not secure and income is not guaranteed. If you are looking to accumulate a target amount by a set date stock market investment may not be suitable as the returns cannot be guaranteed.

Any growth may be liable to capital gains when the child eventually sells the investment but this may be reduced or even eliminated after the childs capital gains allowance has been applied.

Should I take out a stakeholder pension for my child?

Your child may have a stakeholder pension plan from birth contributing up to £2808 a year which with tax relief at the basic rate adds up to a maximum of £3600 invested. Features include the ability to increase decrease stop and re-start a stakeholder pension without penalty. In addition a stakeholder may be transferred to another provider without penalty.

A parent or guardian or grandparent can set up a stakeholder pension and pay the contributions for any number of children under 18. At age 18 the child can start making their own contributions. If buying a stakeholder for someone elses child you must tell the parents to ensure that any pensions contributions made during the tax year do not exceed the maximum limit. The rate of tax relief is set at the basic rate of 22 for those taking out stakeholder pensions on behalf of others.

Stakeholder pension plan providers will normally invest in about five to 10 different types of funds including tracker and actively management funds. Some providers allow you to choose the type of investment you want and may allow you to switch to another fund free of charge.

Setting up a pension scheme for a babe in arms isnt as a crazy as it might once have sounded. The sooner we all start saving for our futures the better. However if you are hoping to fund education or assist with car or even house purchase in the future then a stakeholder pension scheme would not provide the flexibility you require. Only 25 of the proceeds would be available as a lump sum and only at age 55 at the earliest a little late to pay college fees!

Please remember that the current favourable tax treatment of these savings and investments could be subject to change in the future if legislation changes.

Moneyextra.com recommends you take independent financial advice before acting on any article

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2009-03-09 16:50:31 © Moneyextra.com