Money
Managing your money
Saving for your grandchildren
It is entirely natural to want to save for your grandchildren’s future, but first you should ask yourself why, writes Jennifer Bailey
It may seem odd, but before you can work out the best way to put money aside for them, you need to be clear about what you want to achieve.
Do you want the child to know about the money? Are you happy for them - or their parents - to be able to get their hands on it while they are growing up? If so, how quickly and easily? Or would you rather it was locked away until they are older, when it could help them pay for university, or buy a car?
You also need to think about how important this nest-egg is likely to be. Will they have other savings to rely on, or is this it? Are their parents or other relatives already saving for them – and if so, how?
Balanced approach
If your grandchild already has a savings account, should you set up something different to complement it - like a National Savings Children’s Bonus Bond, or a share-based investment? How much risk are you prepared to take with this money - are you ready to take the chance that you could lose some or possibly even all of it?
Next you have to decide how much you want - and can afford - to give. Are you going to add money on birthdays and other special occasions? Or do you want to make a regular contribution? Some investment plans ask you to commit to a set amount. Before you do, remember you may have other grandchildren you will want to treat in the same way. Make sure you factor that into your sums.
Death and taxes
You may also need to consider tax. Just like adults, children can have a certain amount of income before they start paying tax - £5,035 in the tax year 2006/07. The position is more complicated when children receive interest worth more than £100 a year from savings funded by their parents, but money from grandparents is not affected.
And there may be no inheritance tax issues for you to worry about either, so long as the amounts you save conform to certain rules. You have an annual allowance, a small gifts allowance, and the right to give away as much money as you like as long as it comes from your after-tax income (not your savings) and forms part of your regular spending habits.
Any other gifts you make may be subject to inheritance tax if you die within seven years. If your affairs are complicated you may need to take specialist advice.
Having run through some of the basics, let’s have a look at some of the different types of products on offer.
Useful general links:
www.direct.gov.uk
Baby steps: child trust fund
If your grandchild was born on or after September 1, 2002, then they should already have a child trust fund, or CTF, the new government initiative designed to ensure every child has a lump sum at 18.
The state kick-starts the fund with a voucher worth at least £250 at birth, with a second payment at age seven, and the possibility of a third payment at secondary school age, although that has yet to be confirmed.
Grandparents and other relatives and friends can collectively contribute up to £1200 each year. You cannot roll any unused part of one year’s annual allowance into the next and, because the allowance is per child, you will need to liaise with anyone else who may add to the account to ensure you stay within the limit.
Happily all money invested into child trust funds grows tax-free.
Parental choice
Children can only have one CTF, which must be opened with the voucher sent out when the child is born. You can only contribute to the child’s existing account. Parents must choose between three types: cash, shares and “stakeholder”.
A cash account is the simplest, operating just like a building society savings account. The money paid in is completely safe; it attracts a specified rate of interest which is added to the balance each year on the child‘s birthday. Like any savings account the interest can vary, and providers sometimes offer short-term bonuses to boost the rate for a set period or if a certain amount is paid in.
Both the shares and stakeholder CTFs are more complicated. The money paid into these accounts is used to buy different investments, including shares and bonds. The amount the child receives at age 18 will depend not on a set interest rate, but on the performance of these investments.
Because CTFs are long-term products, running until the child’s 18th birthday, the government believes most parents should pick a stakeholder account.
Strings attached, built-in safeguards
Stakeholders come with conditions which are supposed to insulate parents from some of the risks of share investment. Annual management fees cannot be more than 1.5% of the fund value, the CTF must invest in a range of shares, and, crucially, the money in the account is gradually moved out of shares into safer investments, once the child turns 13.
Although all stakeholders meet these rules, they are not the same. Some rely on an individual fund manager choosing particular shares, while others follow or “track” the performance of a particular stockmarket index such as the FTSE 100, which contains the biggest companies listed on the UK stock exchange.
It is also possible to have a shares CTF which does not adhere to these rules about charges and investment strategy. But this option is really only suitable for savvy investors.
All CTF providers have to offer stakeholders – a smaller number also offer cash or non-stakeholder shares accounts. Parents can transfer between different types of account and providers without penalty.
Whichever CTF parents go for, the money automatically becomes the property of the child on their 18th birthday, when they are free to spend it as they choose.
You cannot open a child trust fund for any child born before September 2002, although in almost every case you can access the same investments outside the CTF rules. The only difference is the money will not automatically grow tax free.
Thumbs-up:
Tax free. Boosted by government contributions. Stakeholders offer the advantages of share investment with capped charges and some limitation of risk.
Thumbs-down:
Only available to children born from September 1, 2002. Contribution limits. No control over when the child gets the money or how they spend it.
Useful links:
www.direct.gov.uk
www.childtrustfund.gov.uk
www.hmrc.gov.uk/ctf
www.moneyfacts.co.uk
Back to school: cash and other safe ways to save
Whether or not your grandchild has a CTF, you may want to open a cash savings account for them. There are a number of special children’s products available, often offering better interest than general savings accounts. Some include incentives such as toys and gift vouchers, but you should stay focused on the interest rate and not the freebies.
As with adult accounts, you can choose between instant and limited access, monthly savings, or lump sums, and fixed or variable rates. You can also open a bond - a type of savings account where the money remains locked away for a set time period, after which you receive an agreed amount of interest.
As a rule, the more restrictions you agree to, the higher the interest rate. Some providers pay extra if you agree to deposit a set amount every month - but miss a payment and the interest rate tumbles. Watch out for rules about the maximum you can save per year and how and when you can make withdrawals.
Safety first?
Money saved on deposit is completely safe and, as long as the interest rate keeps pace with inflation, will never be worth less than the amount paid in. However, most experts argue that you would earn a better return if you decided to invest in shares instead. So although you are not risking losing your money, you may be risking not making the most of it. Only you can decide how to resolve that paradox.
If you do stick with cash, you should also consider whether you want to let your grandchild have access to the account either via a passbook or cashcard. This can be an excellent way for them to learn about money - but may also mean they can take money out without your consent. If you are concerned about losing control, it is possible to set it up in joint names, but check the rules don’t allow either of you independent access.
You can open an account in a child’s name without their knowledge, but if they are a non-taxpayer and you want the interest to be paid without any tax deducted (“gross”) their parents must sign HM Revenue and Customs form R85. This allows interest to be paid gross until April 5, after the child’s 16th birthday. If they still don’t pay tax, the child has to fill in another R85 form in their own name. And if for some reason the account has been in your name until this point, it must be transferred into the child’s name before the first interest payment after their 16th birthday, or tax will be deducted.
Whether or not you let your grandchild access it while they are younger, in most cases the money in such accounts automatically becomes the property of the child at 16. Some must be closed altogether by their 18th birthday, although you can find some which will run on until 21. Remember: any R85 form must be rescinded once they start paying tax.
100% security
Another popular option is National Savings’ Children’s Bonus Bonds, which any adult can buy for any child under the age of 16. The money is guaranteed by the government and the interest is automatically tax-free.
You can invest a lump sum of up to £3,000 in units of £25. Interest is added every year, plus a guaranteed bonus is paid every five years until the child’s 21st birthday.
The £3,000 limit is per issue - if National Savings offered 4 Bonus Bond issues in one year, you could invest up to £12,000 for the child.
The bond is owned by the child, but until their 16th birthday, it is “controlled” by their parents, no matter who bought it.
The person who controls the bond can cash-in any number of £25 units at any time, which will be repaid along with any interest and bonuses earned, although the money would not of course benefit from the five-year anniversary payments. No interest is paid on bonds cashed in during the first 12 months.
A premium privilege
Grandparents have a special dispensation which lets them buy Premium Bonds for their grandchildren. The bonds don’t earn interest, but offer the chance to win tax-free prizes.
You are allocated one number for every £1 you invest, subject to a minimum of £100 which would buy 100 bond numbers. Each of these numbers is entered into the monthly prize draw. £100 worth of bonds = 100 chances to win. The maximum holding is £30,000.
The monthly draw prizes range from £50 to £1m. The prize fund equals one month’s interest on the total value of all eligible bonds. The interest rate used to calculate the prize fund, the number of jackpots and the odds of each £1 unit winning a prize all vary over time.
As with all National Savings products, your money is 100% secure, and you can get back all or part of your original investment at any time without penalty, although it will not have earned any interest during the period of investment.
Even if bonds are bought by grandparents, the child’s parents are deemed to be responsible for them, and receive any prizes. The bonds become the property of the child on their 16th birthday.
Thumbs-up:
Simple. Safe. Tax efficient.
Thumbs-down:
Unlikely to make them rich. Higher paying accounts can be restrictive. Interest rates can fluctuate, so there’s a constant need to monitor to ensure the account remains competitive. Typically, children control the money from age 16.
Useful links:
www.hmrc.gov.uk/families/babsi.htm
www.hmrc.gov.uk/taxback/form-r85.htm
www.hmrc.gov.uk/forms/r40.pdf
www.moneyfacts.co.uk/savings/bestbuys/default.aspx
www.nsandi.com/savingneeds/investforachildsfuture.jsp
Student days: Time to investigate some riskier investments?
One of the advantages of starting an investment for a child is that you - and they - have time on your side. This means that if you can afford to leave the money in place until they reach university age, you should seriously consider share-based investments. That’s because historically, shares have tended to grow by more than cash on deposit over the same period. But high returns are not guaranteed, and if you go down this route you should be prepared to lose some - or, in extreme cases, all of your capital.
Legally children under the age of 18 (16 in Scotland) cannot hold shares in their own name, but grandparents can save on their behalf and simply “designate” the investment to the child. You identify the child as the investment’s beneficiary, but remain responsible for it until their 18th birthday.
Alternatively you can set up something called a “bare trust”. This means the investment is in your name, but is held in trust for the child. Again they gain full control of the investment at age 18. It is possible to set up more complicated trusts but that requires specialist advice, and tax may have to be paid.
Safety in numbers
You may feel confident enough to pick individual shares. However, for most people it makes more sense to go for “pooled investments” such as investment trusts or unit trusts. These pool your money with that of fellow investors, using the total to buy shares in a range of different companies, business sectors, and even other stock markets.
There are hundreds of funds available. Some are what’s called “actively managed” - that is, run by an individual fund manager who chooses to buy and sell individual shares. They may focus on (or avoid) a particular industry, companies of a certain size or those from a specific geographical area. Other funds let you access alternative investments like bonds or property.
No such thing as a free lunch?
It is also possible to put your money into “passive” funds, where the manager simply invests in all the shares that make up a stock market index, such as the FTSE 100, which comprises the UK’s 100 biggest listed companies. Such “tracker” funds tend to have lower charges than their actively-managed cousins.
It is also possible to invest in something called an “exchange traded fund”, which acts a bit like a tracker in that it allows you access to a variety of shares from a particular index, but which can be even cheaper.
Whichever investment you choose, make sure you understand the impact that charges will have over its lifespan. There are companies known as “discount brokers” which will refund some of the charges normally levied when you set up an investment.
Higher charges are just one reason to treat with caution the various child-branded investment products which are available. Although they can allow you to invest small amounts, they tend to be expensive and, enticing free gifts notwithstanding, you may not get access to the best or most suitable investments for your circumstances.
Although some funds are designed to produce an income for investors, the main objective of stock market investment is capital growth, which is why they should be held for the long term. You can sell at any stage, but that will have a direct impact on the money you get back.
Assuming the value of the investment has increased, when you (or your grandchild) sell it there may be capital gains tax or CGT to pay on the profit.
As with income tax, everyone (including you and your grandchild) has an annual capital gains tax allowance - £8,800 for 2006-07. Any gain above that is subject to CGT; the rate paid will depend on other income.
Buyer beware
Grandparents should also be wary of another type of stock market-linked investment which is heavily marketed to grandparents by Friendly Societies. Tax Exempt Savings Plans are regular saving endowment policies, designed to be held for at least 10 years. Premiums can be as little as £10 a month.
Their big selling point is that, thanks to the special status of Friendly Societies, you can save up to £25 a month or £270 a year per child, tax free. The lump sum the child receives when the policy matures is also tax-free.
But that is really all they have going for them - the charges on these products are generally high and the money is tied up for at least a decade. As with all shares-based investments, there is no guarantee that you will get back what you invest, but you will definitely have to pay a penalty if you need to withdraw the money early.
Thumbs-up:
Shares have tended to out-perform cash investments. Huge range of funds available.
Thumbs-down:
Returns are not guaranteed. Investments have to be held in grandparents’ name.
Useful links:
www.aitc.co.uk/guide/how_to_invest/children.asp
www.aitc.co.uk/files/factsheets/ChildrenFactsheet.pdf
http://www.hmrc.gov.uk/trusts/
Adults only: Pensions
There is another, rather unexpected, way you could save for your grandchild’s future. Given the widespread concern about the fact that we are all living longer, and the impact of that on our retirement provision, you could take a very long view and start a pension for them.
It is possible to set up what is called a “stakeholder” pension for any UK resident under the age of 75, whether or not they have a job, which is why children qualify. They become responsible for the pension when they turn 18 but cannot access the money in the fund until they are 55, although they do not have to continue contributing to it.
A stakeholder is a type of private pension designed to provide a lump sum which can be used to buy an income in retirement. The amount of money it ultimately provides is not guaranteed, depending on the contributions made, the size of the fund at retirement, and way that lump sum is converted into an income.
All stakeholders must meet a set of minimum standards devised by the government. These include no upfront charges, and a maximum annual management charge of 1.5% for the first 10 years of the policy’s life, 1% thereafter. Providers cannot penalise you for stopping contributions or transferring funds to another scheme, and must accept contributions as low as £20 whether as a lump sum or regular payment – some will accept smaller amounts. Policyholders can take a quarter of their fund as a tax-free lump sum when they retire, which they can do at any time between the ages of 55 and 75.
For those with no earnings (such as children) the maximum you can put into a stakeholder pension every year is £3,600. However, because the government gives tax relief on pension contributions, in practice the most you would invest is actually £2,808. HM Revenue & Customs then adds 22% basic rate tax relief on top. That amounts to another £792 which takes the total paid into the fund up to the £3,600 maximum.
Stakeholder pensions are sold by a range of providers including insurance companies, high street banks and investment managers. Although every stakeholder must meet the government criteria, each offers a choice of different types of funds for your money. These might involve investing in a mixture of cash, bonds, shares, and property.
The main advantage of stakeholders for children is that money invested on their behalf could potentially grow for 50 years. In fact, some providers argue that contributions made during the first 18 years of life could be worth more than the equivalent amount of contributions made during the subsequent 42 years between 18 and 60. (Axa)
But it is important to understand that stakeholders are not flexible investments: under current rules, the fund cannot be accessed before the age of 55 (except through ill-health). And then it must be used to provide an income. So although money saved in a pension may offer your grandchild a better standard of living 50 or 60 years down the line, it cannot help them go to university, travel the world, buy a house or get married in the meantime. Whether that is an advantage or a disadvantage will depend entirely on your perspective.
Thumbs-up:
Tax relief on your contributions. Money could benefit from 40 or 50 years’ stock market growth. Provides for your grandchild’s retirement.
Thumbs-down:
Very inflexible. Money not available until 55. Pension rules could change radically between now and then, potentially undermining the value of the investment.
Useful links:
www.thepensionservice.gov.uk
www.hmrc.gov.uk/stakepension
www.fsa.gov.uk/consumer/06_PENSIONS/index.html
www.pensionsadvisoryservice.org.uk
