No parent will need reminding that children are expensive, there are of course the day-to-day running costs but recent years have seen the financial burden of higher education and that all important first home falling increasingly on parents.
The recent announcement on tuition fees will significantly increase the cost of university, which is less likely to be met through the student working part time due to the current high levels of unemployment. Furthermore, following the credit crunch and despite the falls in house prices, it is hard for first time buyers to get a foot on the housing ladder without a significant deposit.
Add in private school fees or a wedding and any thoughts of a quiet, comfortable retirement might appear to fly out the window. Unless you have significant spare disposable income or capital managing these expenses out of day-to-day income is likely to be almost impossible.
We thought we would take a look at some of the ways in which you can build up capital to help your children or grandchildren overcome the financial hurdles they will meet early in life.
We have therefore put together this short guide to give you some ideas, and tax efficient examples, which might help you to plan ahead.
Firstly, who pays?
Traditionally parents have helped their children out financially. Whether through earned income or using capital saved over a number of years most parents have usually found a way of ensuring that their children have a sound start in life.
However, over recent years parent’s finances have been put under increasing amounts of pressure. The recession has reduced job security, house prices have fallen and wages are not rising like they once were and then there is the need to save for retirement. This has meant that in more and more cases the grandparents have stepped up to help out their grandchildren financially.
Whoever pays, the money has to be found from somewhere.
But where to start?
In order to plan an investment strategy effectively, the starting point is to clarify your targets. For example, are you saving for a lump sum, perhaps to pay for university at 18 or for a wedding at 30? Or, do you need an income, perhaps to help with school fees?
Your time line and how you need that money will be the two most important determinants of your investment strategy. For example if you have eighteen years or more over which to raise the money, you may decide to take a greater degree of risk with your investment than if you are saving for a short term goal.
Ok, I know what I want, where do I save?
The next thing to look at is how much money you can commit as this, along with your time frame and attitude to risk, will dictate which investments there are to choose from.
How much risk should you take? Can you tolerate short-term fluctuations in your capital value in exchange for a higher potential return?
In general, if you have a longer-term horizon you might find the growth potential of some volatile assets outweigh the apparent safety offered by lower risk options. However, even if you are saving for 18 years, if short-term losses will stop you sleeping at night, then the lower risk options are for you.
You do however need to try and get a ‘real return’ on any savings or investments you make, by this we mean a return above inflation so that the buying power of the money you put aside is maintained. Given that you are saving for your children or grandchildren’s future you could be looking at a lengthy timeframe, even low levels of inflation over a protracted period can have an alarming impact on the real value of money.
Inflation is a hot topic at the moment and retaining the purchasing power of your investment over the long term might be difficult without taking some risk.With interest rates at such low levels, many deposit accounts are not paying enough to make up for the price increases we are currently seeing. Over short periods, the risks of more volatile options might not be worth taking, but over 10-20 years, if you want your investment to grow in real terms and not just in absolute terms, you may need to consider other options.
I need an income from my investment
If you are paying school fees or helping to meet the cost of higher education it is likely that you will need to create an income.
Taking an income is possible with many investment products such as ISAs, Unit Trusts and Investment Bonds. There are also some investments which are designed specifically to pay predictable levels of income so that you know where you are from month to month.
Should I own the investment or should I put it in the name of my child?
This is probably the most debated question regarding saving for children.
There are of course rules surrounding which investments can be held by minors, they can open certain savings accounts and will be able to hold the new Junior ISA, indeed the Child Trust Funds (CTFs) were held in the name of the child. However other investments cannot be held by the child.
Often this question comes down to a matter of access and control. Many parents and grandparents want to control how and when the money is accessed, this is of course not possible if it is held in the name of the child, which is the case for example with the CTF.
Other parents like to give their children experience of handling money and being responsible for it, seeing it as part of the education.
In the end many people prefer to strike a balance, with money held in both the child and parents name.
How do I invest tax efficiently?
It is hard enough as it is to save sufficient money to meet all the needs of your children. Inflation is attacking the money you have managed to put to one side, the last thing you need is the tax man taking his slice too. So which vehicles will help you to reduce the tax you pay?
1) Use your children’s personal allowances
Children have the same personal allowance as an adult (£6,475 for 2010/2011 and £7,475 in 2011/12), but as children are generally not earning the allowance is rarely used. If you hold savings in your child’s name fill in a form R85 from HM Revenue & Customs to have any interest received from their account paid tax-free.
However, you need to remember that if you give money to your child that produces more than £100 gross in interest a year, the whole of the income from that gift is taxed as if it were yours.
Unfortunately it doesn’t pay to put all your savings in your child’s name!
2) Individual Savings Accounts (ISAs)
Following a recent announcement from the government both you and your child can use an ISA.
If you are looking to save via an ISA on behalf of your child they are free from both income tax and capital gains. An Equity ISA can hold a wide variety of funds investing in a range of assets from stocks and shares to property, gilts and bonds. Equity ISAs involve a degree of investment risk. There is therefore risk of capital loss
A Cash ISA invests in just that i.e. cash and works in a very similar way to a normal deposit account, but with the added advantage that the interest is not taxed. Whilst your capital is secure interest rates are currently low and the value of your savings may be eroded by inflation.
You can invest a maximum of £10,200 in the current tax year in an ISA with up to £5,100 of this limit held in cash. In 2011/12 this limit will rise to £10,680 of which £5,340 will be available to invest in a Cash ISA.
To hold an Equity ISA though an individual has to be 18, although a Cash ISA can be taken out from 16.
The government have announced plans to replace the Child Trust Fund (CTF) with a new Junior ISA, although existing CTFs will not change. The new Junior ISA will be introduced from Autumn 2011 and although the full details have yet to be confirmed it seems that both Cash and Equities will be able to be held and that the plan will be owned by the child although not accessible until he or she reaches a designated age.
Given their flexible nature, tax efficiency and the wide range of assets which can be held ISAs are likely to remain the first port of call for saving and investing. The annual allowance of £10,200 each year is often sufficient to allow all regular savings to be accommodated, especially when a couple both use their allowances.
3) Child savings bonds
These are offered by friendly societies and allow parents, grandparents, other relatives and friends to all save up to £25 a month on behalf of each child with the maturity amount being free of further tax.
The bond must have a term of at least 10 years, mature on either the child’s 18th or 21st birthday and the contributions must be maintained to earn the tax benefits.
Generally a range of funds are available to invest in and whilst they do offer a valuable alternative due to their tax efficiency an eye must be kept on the charges levied as they can be higher than other alternatives such as ISAs.
4) Child Trust Funds (CTFs)
Although CTFs were stopped in the 2010 Emergency Budget, millions of parents still have active CTF accounts for their children. Parents, family and friends can add a total of up to £1,200 to the account each year. There is no tax to pay on any income or any gains from the fund.
However, as with savings accounts, it remains in the child’s name and they will ultimately have control over how it is spent.
Investing for children is not so different from investing for any other purpose.
You need to decide on your time horizon, whether you are investing for growth or income and think about how much risk you are prepared to take. All of these things taken together will allow you to create your investment strategy.
You then need to ensure that saving is done in the most tax efficient way possible by selecting the right product that not only allows you to invest in what you want to but will offer the most tax efficiency.
If you are concerned about whether you are saving enough or indeed are saving in the right way pick up the phone today and speak to one of our highly qualified and knowledgeable advisers, they can be reached on 0115 933 8433 or 0845 074 7778.