Here in Session 21, we’re going to be talking about saving and investing for our children. Bringing up kids is really expensive. The amounts differ, but one study reckons that raising a child from birth to leaving university costs £222,458 [Source: Guardian]. Most of us fund this from our income but there are steps you can take to smooth the way, particularly for the big bills of university education, house deposit and maybe a wedding. There are also some things to watch for, tax rules you’ll need to be aware of and as ever, some clear action points for you to take.
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Listener Question
I got a question, (and a fantastic email and an iTunes review) from Matt this week. He’s referring back to session 14 on pension income options – here’s the question, paraphrased:
Does a pension fund have to be used to buy just one retirement income option. Is it either Annuity OR drawdown, or can it be both?
Thanks Matt. The short answer is absolutely YES! You can split your pension fund however you like, and arrange an annuity for part of it to secure some level of income, and then place the rest into drawdown to get the flexibility there. In fact, one of my bugbears is that many advisers are too quick to opt for one broad brush solution to retirement planning, when in fact a multi-layered approach could work best.
There are factors at play – cost of advice may rise with multiple solutions. The size of the fund is a factor, as is the risk tolerance and capacity of the client.
Remember, if you have a question that you want me to answer on the show, go to meaningfulmoney.tv/feedback and you can leave me a voicemail there.
Sponsor Message
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Introduction
I’d be loaded if wasn’t for my kids. As true as that is, I obviously wouldn’t change them for all the world. In fact, not only do I not resent their endless drain on resources, they are my main motivation in working hard. I want to give them the best possible start in life. I’m sure, if you have been blessed with children, you want the same for them. Or maybe your kids are grown up and they have children of their own, and you are wondering what you can do to help with their future.
Let’s look at what you need to know, and then everything you need to do to save and invest for directly for your children’s benefit.
Everything you need to KNOW
1 – Know your savings options
There are a few savings vehicles (things you can save into) which are specifically designed for children. Let’s look at these first, and the pros and cons of each.
Children’s Savings accounts
These are just bank accounts branded for children. Usually, they are in joint names of one parent and the child. They can begin managing their own account from the age of seven. Accounts like this often come with free gifts for the child, and can be a great way to get them to know about how money and the banking system works.
The accounts are usually instant access, so the money can be withdrawn whenever you want. There will be precious little interest paid on these accounts, particularly at the moment, but if any interest is paid, it is usually paid with tax taken off.
Children have a personal allowance for Income Tax, just like adults (see session 19) so if they shouldn’t be paying tax (vast majority will not) then you can claim back the tax paid using a form R85 – ask the bank or building society to provide one for you.
There is no limit to the amount of money you can save for a child in this way.
Child Trust Funds
Children born between 1st September 2002 and 3rd January 2011 are eligible for Child Trust Fund accounts. The key point of these is that eligible children were given a voucher at birth and another on their 7th birthday which could be used to open and top-up a Child Trust Fund account.
There are three types of account: Stakeholder, Stocks & Shares and Savings accounts. They are all tax-free and are held in the child’s sole name. There is also an adult ‘registered contact’ on each account who handles the admin until the child becomes an adult.
CTFs are locked in until the child reaches age 18, at which point they can do what they want with the account.
Parents, family members and friends can pay in up to £3,720 per year between them, on behalf of the child, each year.
Junior ISAs
A child under 18, who is NOT born between 1st September 2002 and 3rd January 2011 can have a Junior ISA. They work similarly to the adult versions of an ISA in that interest and investment gains are tax free. The money belongs to the child but they can’t withdraw it until age 18.
A child can have two JISAs running concurrently during their childhood. One can be a Cash JISA, like a savings account but again, with no access until age 18. The interest payable in the account would be tax free.
The other is a stocks and shares JISA, which as the name suggests can be used to hold true investments like shares, bonds and other eligible investment. The value of these can go up and down. Both types can be transferred to other providers throughout the child’s life, but only one of each type can be held at one time. It isn’t yet possible to transfer a CTF into a JISA.
The contribution limit is the same as CTFs at £3,720 per year. That’s per child, so if they have two types of JISA, they will have to spread the money between both accounts.
If the child is age 16 or 17, they can have an adult cash ISA, just another type of tax-free bank account, but with a higher contribution limit of £5,760. They can hold a JISA concurrently with a Cash ISA, so could save up to £9,480 in the final two years of their childhood.
NSI Children’s Bonds
NSI stands for National Savings and Investments, a government backed and guaranteed suite of investment products. Children’s Bonds are sold in batches, called ‘issues’ and each issue runs for five years.
You can save from £25 up to £3,000 per issue and interest is fixed for each five year period and is tax free. At the end of the five years, the bond can be rolled over into a new five year issue, until age 16.
The bond is owned by the child, but can only be bought by a parent (or guardian), grandparent or great-grandparent. The bond passes to the child at age 16
Friendly Society Savings Plan
Friendly Societies are organisations owned by their members, a little like co-operatives, and run for the members’ benefit. They enjoy special tax regimes, but the limits to the amounts that can be saved is small.
For instance if you want to save annually into a savings plan for your child, you can save £270 per year. Saving monthly, the limit is £25 per month, or £300 per year in total.
You can usually set the term of the plan to between 10 and 25 years. You have to pay into the plan for at least three quarters of the term for the benefits to be tax free.
These types of plans usually invest in investment funds of some type, so they can go up and down in value. There are also policy charges to pay.
2 – Saving in the child’s name, or your own
All the types of savings plan above are for saving into the child’s name. They have useful allowances and should be used if possible, but of course, you could just save into an ISA or bank account in your own name and make that money available to your child in due course.
In the child’s name: Pros and Cons
By saving into dedicated accounts in the name of your child, you use the allowances we’ve mentioned above. You can also involve your child and get them enthused about the process of saving because they will see their own name on the bank account, You can take them into the bank to pay money in, or draw money out for a special purchase.
On the downside, saving into a bank account for a child can lead to minor tax implications for the adult concerned. If the interest produced by the amount paid in for the child is more than £100 per year, then the tax incurred on that interest falls on the adult. This is pretty unlikely with interest rates as they are currently, and even then is hardly a big deal.
A major downside is control. All of the child-specific accounts become the sole property of the child at some point. This may or may not be a good thing, depending on the child concerned. While we all want the best outcome for our children, the fact is that some children come off the rails and get involved in terrible things. Most of us would not want a child in this position to suddenly come into hundreds or thousands of pounds when they reach age 18.
In your own name: Pros and Cons
Saving in your own name gives you absolute control over the money. You can ring-fence it in your mind to be for the child’s benefit, but if circumstances mean the in the future you don’t want them to have the money, it remains yours and they need never know of your original plans.
You can use your ISA allowances to save tax-efficiently and keep the money accessible for when the need arises. There are no implications for you or the child of saving in this way.
You could argue that you are using your ISA allowance for someone else when you could be using it for yourself, but that’s your call. A stocks and shares ISA is likely to provide you with far more choice about how you invest for the child, than the limited options available under a friendly society plan, for example.
Probably, using both child-specific plans and investments in your own name is a decent plan.
3 – Compounding
Saving for children is likely to be a long term thing, especially if you start early. Like all long-term investments, your biggest ally is compounding.
We’ve talked about compounding before, but here are some numbers:
If you save £100 per month for 10 years and get 5% growth on your money over the term, you’ll end up with £15,587, having put away £12,000.
If you save for 20 years, the final figure is £41,335. An extra £25,748 for only an extra £12,000 saved. The difference is that the early years’ savings have much longer to grow.
Obviously, the earlier you start the better. Because of the long-term nature of the investment, you should probably consider risk investments like stocks and shares rather than savings accounts. Remember – say it with me – cash is not an investment. Bank accounts are where you keep money for the short term, not invested for the long term. If you have a defined target in mind – to save X pounds by 2025, then the nearer you get to this, you may want to reduce the risk of your investments so that a last minute shock to the stock markets doesn’t mean your plans are undermined.
But generally, you should harness compounding to help you achieve your goals sooner.
Summarise KNOW
#1 – Know the child-specific options
#2 – Know the pros and cons in saving in your child’s name or your own name
#3 – Harness compounding to accelerate your progress.
Everything you need to DO
1 – Consider starting a pension for your child
Most people wouldn’t even think of starting a pension for their infant child, or even their 20 year old, but think about this in the context of our last point – the length of time the money is invested.
Currently, the minimum age anyone can access their pension funds is age 55. If you start putting away £100 for your child into a stakeholder pension from birth until they reach, say age 21, and then just let it grow for another 34 years until they reach age 55, they will have a pension fund worth £303,903. This is assuming a 5% investment return and no inflation. This latter point is a big factor of course, listen to Session 15 for more on inflation and its effects
But what a gift to give your child, a meaningful pension fund which they can add to themselves throughout their career. I have one client who has been doing this and paying into a pensions for his son since birth. That 19 year old already has a pension worth six figures and he can’t blow that money on beer!
You can pay up to £3,600 per year gross into a pension for a child, of which £720 is paid in by the tax man – yes, free money form the Revenue for your child! That leave £2,880 per year that you can save, which is £240 a month.
Pensions offer access to different kinds of underlying funds, so you could choose a fund to suit your attitude to risk, bearing in mind the very long term your money will be invested over. Choose a large, reputable company for your savings.
2 – Use trusts where appropriate
Trusts are a huge part of financial planning, and are hardly understood by many advisers, let alone the general public. I’m going to devote the next session of the podcast to introduce you to the immense power of trusts to help you achieve your personal financial goals, but for this session, let me just introduce them as a separate legal entity into which you can put things and have them looked after in certain ways.
Specifically for saving for children, let’s say you wanted to invest for the benefit of all your children or grandchildren, and you wanted to make sure a fund was available to benefit them all. You could set up a trust fund with yourself and maybe some other family members as trustees. These trustees can then make decisions as to which of the children should benefit and when. So if one child is about to start university, they could be given so much money each year form the trust to pay their tuition fees. Another child who doesn’t go to university, could be helped with some money to set up his own business.
This brings immense flexibility, and can ring fence the money intended for the children in many ways, and protect it against various threats. It is a great way of passing wealth down the generations. You’ve heard of wealthy trust fund kids getting an allowance? This is how the wealthy families organise their finances and you can do the same, even if only on a smaller scale. Bear in mind that money put into a trust can very often not be got back, so you should seek financial planning and legal advice in setting up any trust arrangement.
More on this next week…
3 – Invest for the long term
I know that I’ve already mentioned this, but if you are investing for the very long term, you should be prepared to invest the money in a broad spread of investments. What does it matter if the investment loses some money one year, or even five years in a row, if it is to be invested for 50 years or more?
Parents and grandparents who are afraid of investing in real assets are doing their children a great disservice. I’ve heard a financial planning colleague Saran Allott-Davey of Heron House Financial Management call it being ‘recklessly conservative’ – I couldn’t put it better myself!
Say it again – cash is not an investment. Anyone who puts money in a bank account for a child long term is missing a trick. Any money invested for a child’s long-term future should be invested in markets to a greater or lesser extent. An competent adviser can guide you as to the levels of risk involved in different kinds of investment. Listen to session 16 about Risk and how to mitigate it if you want more detail. But please don’t hamstring your child’s future by being unnecessarily cautious with long-term invested money
Got it? Good!
Summary
Many of us want to save for our kids but find it difficult to balance this long-term desire with our near-term needs. But what a fantastic gift to be able to give our children – a start in life which is free from student debt, or a deposit for a house one day.
Budgeting is the key to consistent savings behaviour – listen to Session 3 for help with that. Your kids will be grateful, and you’ll be able to enjoy watching your kids benefit from your prudence if you start now. It’s never too late to start, so don’t think that you’ve missed the boat if your child is already 15 and you haven’t saved a penny. Remember the best time to start saving for your child is when they are born. The second best time to start is right now.
Outro
That's it for this session of the MM podcast. I hope that was helpful. Did I miss anything? Do you have any tips or tricks that work for you? Any questions?
Please leave any comments or questions in the comments section below and I'll do my best to answer them.
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I hope you enjoyed this session. Next time we'll be talking about Financial Planning using trusts – lots of great stuff to cover there.
If you have any questions about this, go to meaningfulmoney.tv/feedback and leave a voicemail just like Matt did.
Thanks for listening – I'll talk to you next time
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