Investment: Giving the gift of money

Joanna Faith assesses the different options for giving financial gifts this Christmas...

A lump sum investment in a savings plan may not put a smile on a child’s face as they sit under the tree on Christmas morning, but when they head off to university or are scrambling together a deposit for their first home, they will be grateful.

A survey for Baillie Gifford in October revealed the recession has reduced the amount people in the UK are saving for their children and grandchildren. According to the report, almost a third of parents and grandparents are being affected by the economic downturn, stating they have reduced the amount of money they put aside for loved ones.

The festive season could be the perfect opportunity for parents and grandparents to reverse this trend. With the amount people are putting aside for younger generations declining, the savings message needs to be stepped up, says James Budden, marketing director at Baillie Gifford. “Despite some parents and grandparents continuing to invest in these challenging economic circumstances, too few recognise the importance of long-term savings,” Budden says.

There is certainly no shortage of options for parents, grandparents, godparents, relatives and friends. When advising clients on financial gifts, IFAs need to consider three main factors, says Andrew Gadd, head of research at Lighthouse Group: “Risk, accessibility and tax efficiency.”

Stakeholder pensions

A popular option for grandparents is putting money into a stakeholder pension. Older generations worried grandchildren will fritter their savings away as soon as they reach 18 – the age they take ownership of the majority of savings plans – will be reassured the money cannot be accessed until 55 thanks to the increased new minimum retirement age, which comes into force next April.

Thanks to low charges contributing to a stakeholder pension is a cheap approach. There is a maximum charge of 1.5% of the fund value each year, reducing to 1% of the fund value after ten years. Stakeholders are also flexible. You can pay in as little as £20 gross and you can stop, start, increase or decrease regular contributions, and pay in single contributions at any time without penalties.

Another advantage is, as with all pension contributions, there is basic-rate tax relief up to £3,600 per tax year for everyone, including non-earners such as children. This means a contribution of £2,880 into a stakeholder will be topped up to £3,600, which represents a 25% boost to the net contribution.

Adrian Lowcock, investment manager at Bestinvest, says a stakeholder pension is a good long term plan. “Giving a child a pension pot will put them significantly ahead of their peer group long after their parents and grandparents have gone,” he says.

Grandparents also benefit. By making regular gifts to grandchildren, while claiming tax relief within the pension plan, they will over time reduce the proportion of their assets liable to inheritance tax.

Risks associated with any investment, of course, apply. The value of the investments, which make up a child’s pension fund, can go up and down with market performance, so the value of the pension fund is not guaranteed. Gadd says this should not be a major deterrent. “Risk is mitigated by time. There is a long time before a child has access to the money. Because of the time period involved equity-based investments have historically proved to be the best place to invest,” he says.

Monthly contributions could alleviate concern for the real risk-averse. Gadd says saving monthly can be advantageous. He attributes this to pound cost averaging – investing money into the market at regular intervals over a period of time rather than in one large sum.

“This allows the investor to take advantage of fluctuations in the market, while accepting that it is impossible to predict the future,” he says. “In my experience investing gradually in this way can be less risky than making a single large investment. Furthermore, this investment strategy can potentially reduce the average price of investments, thereby improving the potential return over time.”

Risk is not the only downside to a stakeholder pension. Lack of accessibility is often an issue as children cannot get access to the money until 55. “Some grandparents may prefer the savings to go towards a new car, a first house or the cost of university,” says Simon Stannard, senior account manager at Courtiers. For them, a stakeholder pension is obviously not the best option.

Child Trust Funds

For easier access to the money, contributing to a Child Trust Fund (CTF) may be preferable. CTFs are a tax-efficient way of saving as neither the relative nor the child pays tax on income and gains in the account. The child gets access to the fund at 18. The current Labour government gives every child born on or after the 1st September 2002 a £250 voucher to start the account and a top up of £250 when they reach seven years old. Relatives and friends can add to this amount.

There are three main types of CTF account. If you do not want to invest in shares there is the cash or savings account option. Alternatively there are stakeholder or non-stakeholder accounts which invest in shares. The stakeholder accounts have various restrictions on the charges that may be levied and on investment strategy, for example when the child reaches 13 money in a stakeholder account starts to be transferred to lower risk assets or cash. Non stakeholder accounts have greater flexibility.

Generally CTFs tend to have low administration costs but the downside is you can only invest £1,200 a year maximum. Also worth noting is the Conservatives’ plan to curtail the scheme, meaning only children of lower income families and disabled children will receive the £250 voucher.

“The Tories are serious about plans to limit CTF vouchers to lower income families. If you look at the amount of money put into CTFs, it’s significant and we can no longer afford it,” says Malcolm Cuthbert, partner at Killik & Co. “The important thing is the vehicles for voluntary contribution remain for families who wish to save themselves.”

Lowcock says child trust funds should be the first port of call for grandparents wanting to invest money for their grandchildren. “Grandparents can use up their annual IHT allowance by giving up to £250 to anyone as many times as they want up to £3,000 per year,” he says.

Children’s Savings Plans

A flexible option is investing in children’s savings plans provided by the likes of Witan, Baillie Gifford and Invesco Perpetual. As with a CTF, the child gets full control over the money at 18.
Children’s Savings Plans are essentially bare trusts, which allow property to be held for a minor beneficiary in the name of the trustee (usually the parent). The investments are still in the parent or grandparent’s name but they hold them in trust on behalf of the child. The investments are treated as the child’s for tax purposes, which can be particularly useful if the parent or grandparent is likely to be making full use of their own annual capital gains tax allowance or are a higher rate taxpayer. (Although if income in any one year is over £100 then the income is then deemed to be the parent’s.) Inheritance tax liability is also eliminated. When the child reaches 18, they will gain full control of the investments.

Witan’s saving fund for children, Jump, allows parents and grandparents to invest as little as £25 a month. “CTFs can be expensive – there are a lot of overpriced tracker funds out there,” says James Frost, marketing director of Witan Investment Trust. “Savings plans are self certificated, simple to set up and tax efficiency can be achieved through a bare trust.”

NS&I Children’s Bonus Bonds

Cuthbert says the safest and most risk-free option is investing in a Children’s Bonus Bond from National Savings and Investments. Relatives and friends can invest tax-free for a child’s future in their own name. All returns on Children’s Bonus Bonds are completely tax-free for both child and parent. “There’s no risk, no tax implications and the minimum you need to invest is £25 per issue, maximum £3,000,” says Cuthbert. The interest rates were improved recently – 2.5% compound guaranteed over the first five years and an anniversary bonus after five years.

TESPs

A good option for smaller amounts is tax-exempt savings plans from friendly societies. Parents and grandparents can save up to £25 for each family member per month in addition to, or instead of, a CTF. Under current tax laws, TESPs invest your money in a fund that grows free of any income or capital gains tax and the lump sum the child receives will be free of personal income and capital gains tax. The only constraints are the policy must run until the child is at least 16 and run for a minimum of 10 years.

The list of options for giving financial Christmas presents is far more extensive than this. There are cash ISA contributions for children over 16, bank and building society accounts, premium bonds and even Natwest piggy banks which are going for as much as £130 on eBay.

Despite the range of investment options available, Baillie Gifford’s survey found half of those putting money away for their children or grandchildren are using a cash savings account, suggesting cautious parents and grandparents are seeking safety in cash. The next most popular choice is Child Trust Funds at 31%, with 14% using ISAs, 10% using equity-based savings plans, such as investment or unit trusts, and a small number utilising their pensions (3%).

It is highly doubtful a savings plan will feature anywhere on a child’s Christmas list. But if parents and grandparents want to guarantee a more financially stable future for their children and grandchildren, their best bet is to start saving early. It may also be beneficial for parents and grandparents to explore all investment options before settling on the easy and safe cash option. Cash may be attractive now, but the returns will be far greater in the long term if parents and grandparents are prepared to be a bit riskier when it comes to their investment choices.