Trusting in lump sum gives good start to life

If we want to give children a flying start in life, investing for them when young can help to make it a reality.

Whether it is to help fund through university, buy their first car or place a deposit down for their first home, money put aside as early as possible in a child's life can make an enormous difference.

To encourage this process, the Government launched the Child Trust Fund (or CTF for short). All children born on or after September 1 2002 qualify. The aim is to give every child a lump sum when they reach 18.

Under the scheme, an initial voucher worth 250 is issued to the parent of every eligible baby.

That sum is doubled if the family's income is below the child tax credit threshold (currently 14,495). A second voucher will be sent when the child reaches seven. There are discussions about a possible third one at 13.

Neither your child, nor you, will pay income tax or capital gains on the CTF and so it is really tax-efficient. However, the voucher is meant to be a 'carrot' to save. Anyone can add up to 1,200 every year – from one birthday to the next.

That is not just parents or grandparents but any friends or relatives. If both parents ignore the voucher, one of the CTF providers will step in and invest it so that the child will not lose out. No-one can access the funds for 18 years. Until 16, the parent chooses the type of investment held in the CTF.

From 16, to encourage the youngster to develop a better understanding of how the world of savings works, he or she can make the investment decisions.

The CTF matures when the youngster reaches their 18th birthday and he or she can choose what do with the lump sum. Youngsters were asked in a survey by the Social Issues Research Centre on behalf of The Children's Mutual what they would to with a 20,000 lump sum. Top priorities were to continue to save, to pay for higher education and to buy a property.

David White, chief executive of The Children's Mutual friendly society, said nearly a third (29 per cent) of parents already invest their child benefit. He says that only one in five families was saving regularly for their children before CTF was introduced and that the proportion has "now leapt dramatically".

Providers report that over 10m in direct debits are active, resulting in almost 121m in extra savings for CTF plans. The average monthly top-up is 21.20. There are three types of CTF and the voucher must be saved through one of these schemes:

n Deposit.

n Shares.

n Stakeholder.

Many banks and building societies offer cash or deposit CTF plans. They guarantee to return the original capital plus interest earned. While the risk of losing any money is removed, the growth potential is severely limited and inflation will erode the value. It is not recommended for such a long-term investment. Barclays Capital says that in all but one 18-year period since 1899, shares have outperformed money on deposit. Shares have grown by 6.9 per cent a year over the last 20 years but cash by just 3.7 per cent a year.

With a share account, the money is invested in stocks and shares. There is a good range of collective funds available with professional managers to make the stock market selections.

Stakeholder plans also invest in the stock market with charges capped at 1.5 per cent a year. The minimum top-up is 10 and the CTF can only invest in board based funds to help spread risk.

Adding to a CTF can certainly show good results. If just 100 a month was saved, it would mean 21,600 was invested over 18 years. Assuming your money grows by six per cent annually, that would make 38,281 and – through a share account – could be potentially greater. If the CTF is initially a deposit plan, the money plus interest to date can be switched to a share or stakeholder account.

Leeds-based Kingston Unity Friendly Society offers both a stakeholder and a share account but only charges 1.5 per cent annually on either. A tracker which replicates one of the key FTSE indices is one of the most popular ways to invest in a stakeholder CTF. Britannia and Nationwide offer the FTSE All Share while Halifax offers the top 100 share index. However, for such a long period as 18 years, it may be far better to opt for a managed fund where an expert can pick the stocks. F&C, for instance, which started the first investment trust, has a selection.

Some stockbrokers offer a CTF. Redmayne Bentley in Leeds has 10 exchange traded funds, which are shares which in turn track an index. Examples include China, FTSE 250, Japan's Nikkei and commodities like gold and oil. Don't forget a child born a little earlier than the launch of the CTF. They should not lose out and fortunately there are many children's savings schemes.

Ensure that the account is set up on a gross interest or dividend basis as even a baby is entitled to their tax allowance (5,225 this tax year, rising to 5,435 in 2008/09).

Contacts: Children's Mutual 0800 585474, F&C 0800 136420, Redmayne Bentley 0113 243 6941.

Case Study

Louise Clover, a 27-year-old magazine editor, and partner, John Tuper, a TV broadcaster, decided on a stock market based Child Trust Fund for their children, five-year-old Ethan and two-year-old Ashton, pictured.

When the CTF was first available, Louise looked at the providers' websites.

"I was concerned for the long-term investment background," said Louise from Barnsley.

Although she contacted one building society, the couple opted for Foreign & Colonial – known as F&C – as the provider.

They chose the F&C FTSE All Share Tracker which mirrors the index of the same name which the couple can easily follow.

They are adding 10 a month to both accounts and intend to increase their contribution as the accounts get closer to maturity.