It might not be the Frozen Elsa doll or Lego set they're craving, but a future nest egg will help give children and grandchildren a better start in life.
"The first contact most young adults get with money is a bucket load of student debt, so setting money aside for them will encourage them to develop personal responsibility," says Danny Cox at financial planner Hargreaves Lansdown. Danny recommends what to set up:
1. Children’s savings accounts
Children can elect to have bank or building society accounts pay gross interest without tax deducted (assuming they are non-taxpayers). Some accounts are specifically designed for children e.g. Halifax's Children's Regular Saver account pays 6% (fixed for a year). You can compare children's accounts here.
Best for: Short-term savings and money needed before age 18.
Care needed: Parents who set up and pay into accounts for their children will pay income tax if interest is £100 or more a year (£200 if both parents contribute).
2. Junior ISAs/ Child Trust Funds
Once a parent or guardian opens the account for their child, anyone can save up to £4,000 into a Junior ISA or Child Trust Fund (CTF), depending on when their child or grandchild was born. The savings become the child’s at age 18 and are virtually tax-free.
For savings of less than five years a cash Junior ISA or CTF is a sensible option. For longer-term savings the stock market is likely to produce dividends. The money could be used to offset the costs of university fees or towards the deposit for a new home. Junior ISAs have the same tax benefits as adult ISA - No capital gains tax and no further tax on any income. Interest on cash is paid gross.
Save £300 per month from birth and your child may benefit from a lump sum of nearly £104,000 at age 18, assuming a 5% return.
Transfers from CTF to Junior ISA are expected to be available from 6th April 2015. You can compare JISAs here.
Best for: Either short or longer-term tax efficient savings to age 18.
Care needed: Savings cannot normally be accessed before age 18.
3. Unit trusts/OEICs or shares under a bare trust
Investing in the stock market has the potential to provide returns in excess of cash deposits over the long term although this is not guaranteed. Unit trusts and OEICs (Open-Ended Investment Companies) are funds where investors money is pooled with other investors to spread risk and to benefit from the expertise of a fund manager. However children cannot own shares or funds before age 18.
One option is to set up an account under a 'bare trust'. This is the simplest type of trust and is created when you make a gift into a designated investment account with the intention of creating a trust. The child is the beneficiary and there are normally two adults acting as trustees. The child becomes automatically entitled to the investments at 18. However, as a trustee, you can distribute money earlier if you need to, for example to meet school fees.
In the majority of cases any tax liabilities fall on the child but in practice there is usually none to pay.
Best for: Medium to long-term investment until age 18 or school fees planning.
Care needed: Parents who set up and pay into these arrangements for their children will pay income tax if interest or dividends are £100 or more a year (£200 if both parents contribute).
4. Premium Bonds
Parents and grandparents can buy Premium Bonds on behalf of under-16s. The minimum purchase is £100 worth of bonds; the maximum holding is £40,000. The prize pool is based on an interest rate of 1.35% tax-free, and actual winnings are down to luck. The odds of a single bond winning in any one month are 26,000 to one, and each month your child has a chance of receiving a tax-free prize of between £25 and £1 million. You can buy premium bonds here.
Best for: Absolute security and the chance of winning a big prize.
Care needed: There are no guarantees of winning a prize and the value of prizes could be lower than the interest on a Junior ISA or CTF.
5. Junior SIPP
You can put a maximum of £2,880 into a Junior SIPP (self-invested personal pension) for a child each year. The Government will add £720 in tax relief, boosting the value to £3,600. The investments then grow free of further UK income and capital tax. This is highly tax efficient and can provide a firm foundation for their retirement plans. The £2,880 also falls under the £3,000 annual gift limit for inheritance tax (IHT), thereby exempting it even if you die within seven years. This is one way of transferring money IHT-free to a child.
Save £300 a month from birth until age 18 into the Vantage Junior SIPP and your child's pension could be worth £1.2 million when they come to retire at age 68 (assumes 5% growth after charges).
Best for: Highly tax-efficient ultra long-term investment for retirement.
Care needed: It is important to remember pension funds cannot normally be accessed before age 55.
Find out more about Junior ISAs here, plus why you should save in an ISA and how to give a helping hand with the family's finances.