The Government raised the annual allowance for youngsters for this new tax year
It is a sign of the times that when a new child is born, many parents and grandparents start thinking immediately about how they can help the little one face the big financial challenges that await them.
These hurdles may be some years down the line – for example, paying for university and putting together a deposit for a home – but saving early is essential. And it can be done with the help of a special tax perk – a Junior Isa.
This entitles parents and grandparents to open up a tax-friendly account on the birth of a child, save on their behalf and keep the pot out of the taxman’s reach right until adulthood and beyond.
The Government is so keen to seed the savings habit early it even raised the annual allowance for youngsters for this new tax year on April 6 – from £4,260 to £4,368 – while the adult Isa allowance remains unchanged at £20,000.
Sarah Coles, of broker Hargreaves Lansdown, says: ‘A nest egg from a Jisa at age 18 is a brilliant way to make a start in adult life. The sooner you get going the better. The first years of parenthood are eye-wateringly expensive, but family and friends are often happy to contribute – to celebrate your child’s arrival – or for birthdays and Christmas.’
Figures from Revenue and Customs reveal that nearly six out of ten parents choose to save via cash deposits for Jisas. Sums from account scrutineer Moneyfacts suggest that a parent investing the full allowance this year and earning the best rate currently available – 3.6 per cent – would see their fund grow to a total of £8,256 over 18 years without having to add a penny.
But advisers say the lengthy time horizon available makes Jisas a better bet for equity investment as over time returns from shares tend to far outpace those on cash. The lucky few who can afford the full annual allowance every year could build their child a healthy pot by the time they turn 18, enhanced by the magic of compounding.
Laura Suter, of broker AJ Bell, has done the sums. She says: ‘Based on 5 per cent growth a year with the full allowance put away from birth, assuming this year’s £4,368 allowance remains unchanged, you could have more than £129,000 by age 18.’
Setting up monthly contributions is a more affordable and pain-free way to save. Coles says: ‘If you arrange a direct debit for the payments each month, you won’t notice the money coming out of your bank as much. And by drip-feeding money into the market, you remove the problem of timing it.’
The drip-feeding method is often known as pound-cost averaging. This provides protection if the stock market falls just after you have invested your money and smooths out returns.
A key attraction of a Jisa over an Isa is the enforced savings discipline – as the money is locked away for 18 years
The portion already saved will be dented but the future contribution will benefit from being purchased at a lower price. Setting aside £50 a month from birth would also produce a very useful sum of nearly £18,000 by age 18 – and you would have contrib uted just £10,800 during the period.
This again assumes 5 per cent annual growth. Suter says: ‘Combine starting early with patience and you are rewarded with the benefits of compound growth. This is what happens when savings grow each year and then in future years you receive growth on that growth.’
A key attraction of a Jisa over an Isa is the enforced savings discipline – as the money is locked away for 18 years. Toby Triebel, chief executive of digital broker Wealthsimple, says: ‘Once money is contributed it cannot be withdrawn until your child turns 18. This means you will not be tempted to pull money out or use it for yourself.’
Though children are entitled to take control of the pot when they reach 16, it is only at age 18 that they can dip into the fund or cash it in. If they do not need the money immediately the account will automatically convert into an adult Isa to continue the tax-free benefits. For 16 and 17-year-olds, a quirk in the rules means youngsters – or parents on their behalf – can contribute to both a Jisa and a cash (not investment) based Isa in the same tax year – so a maximum £24,368 per tax year.
Cash, funds and investment trusts
If cash is king in your household then there are some inflation-busting rates available. The best include Coventry Building Society (3.6 per cent), Danske Bank (3.45 per cent) and Darlington Building Society, TSB and NS&I which all pay 3.25 per cent.
For those happy with equities Hargreaves’ Coles says one solid investment fund to consider is Lindsell Train Global Equity. It invests in some of the world’s strongest companies and has a good performance record.
She adds: ‘The manager invests in some popular household names, including Nintendo and PepsiCo – the company behind Pepsi and Walkers crisps. When your teenagers are getting to grips with investment, it is far more interesting if they have a stake in brands they know and love.’
If cash is king in your household then there are some inflation-busting rates available. The best include Coventry Building Society (3.6 per cent), Danske Bank (3.45 per cent) and Darlington Building Society, TSB and NS&I which all pay 3.25 per cent
For a riskier option parents can consider smaller company or emerging markets funds that offer long-term growth potential. Coles says: ‘We like Marlborough UK Micro-Cap Growth. The fund invests in some of the UK’s smallest listed companies, which comes with added risks, but it also means the managers do find hidden gems. It has a phenomenal track record.’
For an even spicier investment she suggests investment fund First State Asia Focus. Investment trusts are another option. Like funds, they are invested in a wide range of companies, but are traded like shares on the stock market. Broker Interactive Investor says nearly one in five of its Jisa customers pick investment trusts.
The most popular include Scottish Mortgage, Woodford Patient Capital, F&C, BMO Global Smaller Companies and Witan. Passive investments which tend to track an index of equities rather than employ expensive managers are also popular because charges are low.
High charges can eat away at investment returns over long periods. Of Interactive Investor’s most popular funds, two are passive – Vanguard Lifestrategy 100 per cent (wholly invested in equities) and Vanguard Lifestrategy 80 per cent (80 per cent equities, 20 per cent bonds).
Digital broker Wealthsimple offers a range of passive investments, with varying risk levels, for a minimum investment of £1. Triebel says: ‘About 60 per cent of customers are in a balanced portfolio and 27 per cent in a growth portfolio. They can change the risk profile any time by speaking with an investment adviser.’
Wealthsimple includes over the phone advice as part of its fees, which are 0.7 per cent a year for under £100,000 invested with fund fees averaging 0.18 per cent. To celebrate the Duke and Duchess of Sussex’s forthcoming arrival, Jisa investors who sign up with Wealthsimple in the same month the Royal baby is born will be charged no platform fees in the first year.
How to breathe life into child trust funds into child trust funds
Huge numbers of Jisas being taken out now are in fact opened by parents transferring money from a Child Trust Fund, the precursor arrangement available to children born from September 2002 – but replaced in 2011.
Though you can still hold and top up the old plans, many transfer them to Jisas to gain more flexibility. AJ Bell’s Suter says: ‘Many old plans were invested with friendly societies which offer limited investment options.
Also on the cash front only one building society offers a CTF. Jisas offer more choice.’ She warns: ‘If you transfer a Child Trust Fund you need to move the entire balance to a Jisa – you can’t have both accounts open at once. But helpfully the amount transferred won’t count towards your annual Jisa limit.’
Ross Duncton, of investment house BMO Global Asset Management, says: ‘The named person in charge of the CTF will usually have to complete an application form. It should be relatively easy and hassle free but it can take up to 30 days to transfer.’
Programmer Damian Cannon transferred his son Joshua’s CTF to a Jisa nearly four years ago so he could put money in racier investments. He says: ‘You can take that kind of risk when they are young. I bought Dragon Oil shares which doubled in value. I sold them and then last year put most of the money into investment trust Smithson and the rest in a firm called Burford Capital which funds legal cases.’
He expects Joshua, who recently turned 16, to spend the proceeds of his Jisa on setting up his own computer games company – his main passion. There are about one million unclaimed child trust funds worth more than £1.5 billion which parents could be putting to good use for their kids. If you cannot remember the provider, you can trace it by filling in an online form from HM Revenue and Customs.
You can even start a pension piggy bank
Parents looking beyond help with a property deposit or university costs could consider a pension for their youngsters. The big drawback is that the money will be locked away for more than half a century as a pension cannot be accessed under current rules until its owner turns 55 at the earliest.
But for wealthy families who may have used up all other forms of taxefficient saving for children it can make a nice long-term investment. The rules allow relatives to squirrel away up to £2,880 a year in a pension for a child and have it topped up with tax relief to £3,600.
Anyone starting one for a newborn now would pay in about £52,000 over 18 years – and receive a Government top-up of nearly £13,000. Jason Hollands of wealth manager Tilney says: ‘Assuming investment growth of 5 per cent a year until the child is 65, they could end up with a £1.2 million pension pot.’
With such a long-term horizon, parents can afford to pick more adventurous investments for the pot such as emerging markets. Hollands adds: ‘Generally, with a pension for a child, I suggest investing globally through international funds such as Scottish Mortgage and F&C.