Your investment choices for your children...
My daughter turned three this week, so I've been giving some thought to her future needs and finances, as well of those of her big brother.
Sadly, my own parents divorced when I was a baby (I've always been a troublemaker!), leaving my mother to raise two young children on her own until she remarried several years later. I remember two things from my early life: my mother worked long hours in low-paid jobs, and she balanced her budget very carefully so as to make ends meet without getting into debt. Thus, there wasn't much left over for treats or luxuries.
Cue Monty Python's Four Yorkshiremen sketch: "Well, of course, we had it tough."(!) Fortunately, my wife and I have decent incomes and assets, which enable us to make modest financial plans for our children without compromising our current standard of living. Without further ado, here are five ideas to give a child a financial leg-up in life:
1. Child-branded investments (yuk!)
First off, I'm going to warn you against getting suckered into buying investment products aimed specifically at children. In particular, I'd be very wary of any financial products which use cartoon characters or celebrities to encourage parents and grandparents to part with their cash. Many of these products (especially so-called 'tax-free savings plans') have horribly high charges which gobble up a large slice of your investment returns. Avoid like the proverbial plague!
2. Child Trust Fund (CTF)
A Child Trust Fund is a tax-free shelter for kids into which parents, grandparents and other relatives and friends can deposit up to £1,200 a year.
Each child born after 31 August 2002 is given a CTF voucher by HM Revenue & Customs worth at least £250, which can be put into cash, investment funds or directly into shares. You can learn more about CTFs here
On my daughter's birthday, I put more money into her shares-based CTF. Each year, I use her cash pot to buy some shares in a single transaction, in order to keep dealing costs to an absolute minimum. So far, she's done very well: the shares which I bought her in September 2005 are up roughly a third (33%) in thirteen months. This is a super start and one which I'm unlikely to repeat!
However, if Miss D'Arcy makes, say, 9% a year after charges on her £268 voucher plus my £1,200 a year, she would have over £55,000 coming her way on her eighteenth birthday. This should be enough to see her though university or whatever she decides to do in her early adulthood. If she takes after her mother, she'll be sensible and won't splurge her windfall, but if she takes after me, who knows what might happen!
Some parents are surprised to learn that they can open a personal pension for a child and pay in up to £2,808 per tax year. As a bonus, the government adds 22% tax relief to these contributions, which turns 78p into £1. A contribution of £2,808 is boosted by £792 of tax relief and becomes £3,600, which is the upper limit for tax relief on payments into a personal pension from someone without any earned income.
Thus, it's possible for parents to build a massive pension pot for a young child, simply by taking advantage of tax relief and the compounding power of long-term investment returns.
For example, if I gave my daughter £2,808 today, her £3,600 pension pot would be worth over £975,000 sixty-five years later, growing at 9% a year after charges.
Even taking inflation (rising prices) into account, it would only take a few years of contributions at this level to build a child the only pension pot s/he would ever need. Hence, I'm going to find a pension with ultra-low charges (probably a Stakeholder pension or Self-invested Personal Pension) and open one for my son and daughter, funded by a windfall which I recently received from some shares.
4. Savings accounts
A child doesn't have to pay tax on up to £100 of savings interest earned each tax year on capital given to them by a parent (so that's £200 from two parents). This is usually more than enough for most children, because to earn over £200 a year at an annual interest rate of 5% would require a cash pot of £4,000 - more than most kids have to their names.
In order for your child's interest to be paid tax free, complete and submit a form R85 to your local building society/bank branch. Also, note that interest earned on cash gifts received from anyone other than parents will usually fall well within a child's personal tax allowance, currently £5,035 for the 2006/07 tax year. Hence, it makes sense to split out contributions from parents, perhaps by putting them into a separate account. Read more in The Best Children's Savings Accounts.
5. Tracker funds
Sadly, children born before 1 September 2002 (including my son) can't have a CTF tax shelter. However, I'm keen for my boy to invest in the stock market, so we've agreed on an investment strategy.
Hence, I'm going to invest a lump sum in the £355 million Fidelity MoneyBuilder UK Index Fund in my name, with my son designated as the 'beneficial owner'. I chose this fund because it's the cheapest index-tracking fund in the UK, with a total expense ratio of just 0.3% a year. Indeed, its charges are a tenth of those charged by some actively managed funds -- and those ultra-low charges give my son a headstart from day one!