Investing for the financial future of your children
Investing, rather than just saving, for your child’s future can pay dividends, setting them up for the best start in their adult lives. Invest as early as possible for their university education, a first house deposit, or even start pension savings, and you could give them a substantial pot of money once they leave the nest. Here are some ways you can invest for a child.
Why invest instead of saving in cash?
Historically, the returns you can expect to receive from investing in financial markets are higher than the interest you can build on cash savings. There’s no guarantee of course as investments can fall as well as rise, but over a longer time frame, investments have performed better than cash, time and time again. That’s particularly true when cash interest rates are very low, in fact if they’re lower than the rate of inflation, then over time the cash pot will actually be worth less in real terms even with the accrued interest.
For example, say you have just become a parent for the first time and you want to start putting money aside for your newborn. If you paid £100 a month into a cash savings account for the next 18 years, assuming an interest rate of 1%, the pot would eventually be worth £18,899 (adjusted for inflation). However, if you put that £100 a month into a Junior ISA investing in stocks and shares, assuming an annual charge of 0.4% and a return of 5% per year, you might have a pot worth £26,218 (after inflation) by the time your child reaches 18.
Which product should I choose?
- Junior ISA
To help you save in the most tax efficient way, look for products that are held within tax wrappers so that the money is insulated from the taxman. A popular product to invest for children is the Junior ISA. You can choose a cash or a stocks and shares version, or split your annual allowance between the two types. You can put in £4128 every year, and the money is locked away until the child reaches 18, when it converts into an adult ISA without losing any of the tax-free benefits. Junior ISAs were introduced to replace Child Trust Funds. Although the older products still exist, if you have one of these you can convert it into a Junior ISA.
You can set up a trust for a child and hold it in your name as a trustee until they turn 18. There are different types, such as a bare trust which the child has the right to access when they reach adulthood, or a discretionary trust which gives you more powers in terms of how and when the assets are distributed. Trusts can be expensive to set up and administer, so are usually used for larger pots of money or assets like property. The rules are quite complex so you should take professional advice from a solicitor or financial adviser.
- Self-invested personal pension (SIPP)
It might seem strange to think about investing in a pension for a child, but it actually makes sense because they have time on their side. A relatively small contribution now could turn in to big money later because it will have so long to grow. The main advantage (or disadvantage, depending on your point of view) of SIPPs is that the money paid in is inaccessible until the beneficiary is 55. With a Junior ISA or a trust, the money could be withdrawn when the child reaches 18 to be used for university fees or a deposit on a house. But, looking 55 years out, anything could happen. Successive governments tend to mess about with the pensions system, and the pension age is rising, so the goalposts might move in years to come. But, under today’s rules, you get 20% tax relief on contributions you make into a pension up to £2880 a year, which means it is topped up to £3600 by the government. If you invested your child benefit of £82.80 a month and continued paying in this amount for 55 years, assuming a modest average growth rate of 5%, the pot would eventually be worth £289,207.
- Adult ISA
There’s nothing to stop you from putting money away into your own adult ISA for your child as long as you have some annual allowance left over. On the plus side, you’ll then have more control over the money and potentially have a bigger allowance to play with. However, it’s important to remember that as soon as you transfer the money to your child it comes out of the ISA tax wrapper and will lose its tax-free status. You’ll need to make provision for the money in your will too.
How much risk should I take?
Risk appetite is a crucial part of the investment equation when you’re investing for yourself. But what about when you’re investing on behalf of someone else? Your gut feeling might be to play it safe because the money is not really yours, but you could be doing the child a disservice if you don’t allow their future nest egg to reach its full potential. The younger the child is, the more time the money has to grow, so the more risk you should consider taking to maximise the chance of a better return. You should reduce the portfolio risk as you are approaching the investment target date. If you are investing on behalf of an older child or a teenager who will withdraw the money at 18, you will have less time for the peaks and troughs of stock market movements to smooth out, so you might want to invest with a little more caution.