Kids may not have incomes of their own, but they have one big advantage on their side: time.
If you start saving for your child when they’re knee-high to a grasshopper, then by the time they reach adulthood they’ll have a healthy head start on the big wide world.
Whether it's to help fund the cost of university, raise a deposit on their first home, or even start their own retirement fund, it’s worth taking full advantage of those first 18 years of compound interest.
Here are some of the main options and how to weigh them up.
What should I consider when investing a lump sum for a child?
When it comes to investing for children, there are several factors to consider before choosing where to put your cash, such as:
- Timescales – how long will it be before you or they need to access the funds
- Risk – how much risk you're prepared to take to aim for a better return on your investment
- Tax – how tax-efficient investment plans can make a difference to returns
- Charges – what are the associated costs involved in setting up, managing, and accessing a financial investment plan
Your financial adviser can help you decide on the right investments by explaining any associated costs, what access arrangements are in place, and any inheritance tax implications.
Junior cash ISAs and junior stocks and shares ISAs
A junior ISA (or JISA) is essentially like an ordinary long-term savings account for children, except there is no tax on the interest or growth.
With a junior stocks & shares ISA, your money is invested in stocks and shares (obviously!) but also in bonds and other assets, usually via funds.
Of course, investing in stocks and shares means there's a higher level of risk, and the value of investments can go down as well as up.
With junior stocks & shares ISAs, all gains made on their plan are reinvested.
This means that there could be a larger sum to invest, and your child's money could grow at a much faster rate than if the gains were paid out.
Compared to a junior cash ISA, this can be an attractive option because rates paid on cash savings at the moment are low.
The investment is free from capital gains tax, so is the obvious choice for holding non-cash assets until your child’s ISA allowance is used up.
It’s important to remember that ordinarily, children are taxed like adults. If a child has no income, they won't be taxed, but if shares are held in their name (outside of a JISA) and these grow in value, then the growth is subject to capital gains tax at 20%.
Interest on cash is also taxable – technically. If cash savings earn more than £1,000 interest then any interest above this rate is subject to income tax at whatever rate that person pays.
However, with interest rates currently very low, you’d need a vast amount of savings to earn over £1,000 in a year… so this would apply only to a very few (and very spoilt!) children, if any.
Things to note about JISAs
- There are restrictions on how much you can put into a Junior ISA each year, and it's significantly less than adult ISAs – the annual limit is £9,000. So keep track of how much you contribute so that you don't go over this limit. (That said, if you have kids and have used up your own ISA allowance, using their JISA allowance in addition can give the family some added savings capacity.)
- Parents or guardians with parental responsibility can open a junior ISA and manage the account, but the money belongs to the child. Once open, anyone can contribute, so it's perfect for family and friends to gift money over time.
- The child can take control of the account when they turn 16 but, as a junior ISA is a long-term option, they cannot withdraw the money until they reach the age of 18. Once you've paid into it, it's no longer legally yours but your child's, and you won't be able to take it out again yourself.
- As the money is your child's, when they're able to get their hands on it, it's up to them how they spend it. Parents who set up the plan might have had it in mind that the investment would pay towards university fees. The recipient, however, may have other ideas about how they want to splash their cash. That said, most families should be able to come to some arrangement here.
- Each child can have one junior cash ISA and one junior stocks and shares ISA during their childhood, and it's possible to transfer each between different providers.
- If the child is aged 16 or 17, they can take out an (adult) cash ISA and save up to £20,000 a year, as well as up to £9,000 a year in a Junior ISA. This makes young adults potentially the most tax-efficient savers around – provided, of course, that they can get hold of the money to take advantage of these perks.
How much could a Junior ISA make?
Assuming a very optimistic scenario and a wealthy family, if you were to invest £9,000 a year into a JISA from birth to age 18, and the fund achieved a growth rate of 5%, your child could achieve total savings worth £228,919.
This equates to gains of £66,919 on an investment of £162,000.
Bear in mind, however, that stocks & shares are volatile and do not grow at a steady rate.
Although average growth over 18 years might well achieve something like 5% per year, this would come in the form of peaks and troughs, including periods of negative growth and dips of big losses.
Therefore, if you have a particular goal in mind (such as university fees) you should monitor the JISA carefully in the final few years, and consider transferring it to cash when it is doing well.
Try not to withdraw it after a slump, as this will ‘lock in’ any losses.
Child Trust Fund
Child trust funds (CTFs) are no longer available, but If a child was born between 2002 and 2011, they might have a CTF. If so, you can still contribute up to £9,000 a year into it.
The money belongs to the child, and they can only take it out when they turn 18, although they can take control of the account when they're 16.
There's no tax to pay on any CTF income or any profit it makes. Since April 2015, parents have been able to transfer savings from Child Trust Fund accounts to a Junior ISA.
On the face of it, it might seem rather strange to kick off a pension fund for someone still in nappies, but it can be a very smart choice.
This type of long-term investment could deliver a substantial sum by the time junior reaches 55 – and they'll be delighted at their parents' foresight and planning.
Up until the age of 18, a Junior SIPP is managed by a parent or legal guardian, who makes the investment decisions.
And, as a Junior SIPP is a long-term investment, more investment risk can be taken to potentially improve investment growth.
An investment of up to £2,880 per year can be paid into a Junior SIPP, with tax relief of 20% added to any investment.
What makes a Junior SIPP special is that most people don't start their pension until they're working.
Starting a pension aged zero may add another 18 to 20 year's growth and contributions to a pension pot before its holder even starts his or her first job.
This financial head start could have far-reaching consequences for a young person – from having more disposable income while they are younger to being able to retire with a sizeable pension pot.
For example, if you made an annual contribution of £2,880 into a Junior SIPP, tax relief at 20% would mean that a total of £3,600 goes into the pension each year.
This amount would be invested in a fund or number of funds, which would generate growth.
This growth would vary (and in some years, there may be no growth at all), but if it averages at 4% per year, by the child's 18th birthday, the pension pot would already be worth around £95,000.
Even if no further payments are ever made into this pension pot, interest at 4% will grow the pot to more than £620,000 by the time the 'child' reaches the age of 65.
NS&I premium bonds
Back in the day, buying premium bonds as gifts for children was popular with parents and other family members.
After all, holders of premium bonds are entered into a monthly prize draw, where they could win between £25 to £1 million, tax-free.
While this sounds attractive, the reality is that, unlike other savings accounts, premium bonds do not pay interest, which means their value will gradually decrease as inflation reduces spending power – unless, of course, you get lucky and win some prizes.
According to the Money Advice Service, on average, one in three people win a prize each year with a £1,000 investment.
If you had £45,000 of premium bonds and, as suggested by Money Saving Expert, average luck, you could win around £1,500 in prizes over a five-year period. Any prizes you do win are free from UK income tax and capital gains tax.
Although you can keep buying premium bonds for your child until you reach the maximum holding level of £50,000, they are generally more suitable as small gifts of £25 or more.
In 2020, NS&I reduced the interest rate payable on premium bonds from 1.40% to 1.00%, so it may not be the best option if you're looking for a good return to build a worthwhile lump sum.
However, for those worried about losses due to financial crises, it’s worth remembering that premium bonds are backed by HM Treasury, so all the money you invest is 100% secure.
Anyone can buy premium bonds on behalf of a child but must nominate a parent or guardian to look after the bonds until the child reaches the age of 16.
What are the benefits of regularly saving for a child?
Saving for a child today is a wonderful gift for their future.
Not only can they start their adult lives with some money in the bank, but getting children involved with saving early also helps them learn important lessons about money and help them become financially savvy – an important life skill.
The most important point is the first one: long-term investments benefit from the magic of compound interest.
This results in savings growing like a snowball over time – meaning the more you have, the faster it grows, in a virtuous circle. With 18 years ahead of them, a child can use this time to really make the most of this benefit.
Going back to the junior self invested personal pension (SIPP) – the pension designed for a child – if you (or more likely, your son/daughter) were to continue to pay into that pension after the age of 18, adding to their investments, and assuming growth remains constant, a payment of £180 per month throughout their working life could result in a final pot size of £1 million.
This is quite possibly the most affordable long-term route to a millionaire's retirement.
Should I seek professional financial advice?
Everyone's circumstances are different, and it's true that some people will stand to benefit from advice more than others.
Yet, there are far more people who could reap the rewards of financial advice and avoid the hazards of not doing so.
Financial advice doesn't just cover the big decisions, but the details too. Particularly if you have a large lump sum to invest, a financial adviser can help you find the very best places to make it grow.
If you found this article useful, you might also find out guide on teaching kids about money informative, too!