Investing for Children - Part 2
Last month, I looked at the ways in which investments for children could be held. This article is concerned with the various forms of investment that are available. The ultimate purpose will determine the type of investment chosen. Thought will have to be given to the term of investment and the risk profile. Also, some consideration should be given to guarantees, if they are important.
According to the office of National Statistics, the annual birth rate in the UK has averaged between 700,000 and 800,000 over the last 20 years. Food for thought!
Last month we looked at trusts and their advantages. This article concentrates on 4 different types of investments that are designed for children. They are National Savings Children’s Bonus Bonds, Friendly Society Savings Plans, Bank and Building Society Accounts and Equity- Linked Investment Plans.
National Savings – Children’s Bonus Bond
The minimum investment in this plan is £100 and the Maximum is £1,000 and the bond needs to be held for five years to benefit from the guaranteed rate of interest, that is automatically reinvested in the bond to increase its capital value at redemption. The current issue of this plan offers a guaranteed return of 4.05%pa, as long as the investment is held for five years. If the plan is encashed prior to the five years, the interest rate is only 2.5% pa.
Investments in children’s bonus bonds are held for a succession of five-year periods, until the child reaches age 21.
The Governments stinginess with the interest rates on National Savings products is made all the more visible by the interest rates available from bank and building society savings accounts. Even the best no notice bank account has a better interest rate than the bonus bond. Typically, they offer 4.55% and remember, because children are non-taxpayers, they can have the interest paid, tax-free.
Children’s bonus bonds threaten to lock savers into a low fixed rate for five years, while the bank accounts at least have the ability to increase rates if circumstances change. It is also difficult to see why capital savings should be placed in a no risk asset for five years, a period long enough to ride out fluctuations in the value of equities.
Friendly Societies
These societies have been around since 1948 and offering plans with a minimum investment term of 10 years. They have the advantage of the investment being able to be registered in the child’s name. The maximum monthly investment is £25 and the fund grows tax-free. The advantages of the tax-free growth and tax-free contributions do not automatically make these products good ones. If the performance is poor, no amount of tax concessions will make them good long-term investment vehicles.
There are great differences in the level of risk involved in the various savings plans for children. However, some parents may feel comfortable with greater risk when the investment term is long and the potential for higher returns is great.
Bank and Building Societies
Many parents open accounts with banks and building societies when children are born. This is generally done as financial gifts are made when a baby is born. These gifts can be from £10.00 to maybe a few hundred pounds. Parents would not have considered any other form of investment, as these gifts are usually unexpected and the deposit would certainly be the best home for that cash. It is only when the parents or grandparents address longer term plans for the children such as school fees, university funding or even weddings, that other forms of investment are considered.
Unit Trusts, OIECS and Investment Trusts
These three forms of investment are all similar, in that they are all collective investment vehicles. I think it would be wise to leave in depth descriptions of each of them until another article.
However, they are very useful plans when considering longer-term investment for children and grandchildren. The returns are generally related to stockmarket performance, so a long-term view must be taken. In this column previously, I have mentioned that investment using these plans can be made in almost any market in the world. The level of risk can be decided at the outset. Because of their nature, profits are potentially subject to Capital Gains Tax. I say potentially, because if these profits are within the annual Capital Gains Allowance, then no tax would be payable. This does make them tax-efficient. Any dividends may be subject to income tax.
Having come through a two-year period of poor investment returns, many fund managers now believe that we are in for a period of growth. Although it may seem like a bad time to consider investment, history tells us that after a couple of years of poor returns, it is likely that some good gains can be made in the few years that follow. Given that this type of investment for children is going to be longer term, this may be the thing to form part of the overall plan. Many of the better investments within this type of plan have annualised returns of 10% or more over longer periods. Past performance is not a guide to future returns. As always, expert advice should be sought before considering any of these plans.
The ideas within this article are not exhaustive, but hopefully will provoke some thought as to how best to serve the needs of children and grandchildren.
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