Investment trusts are an ideal vehicle when it comes to building a nest egg for clients' children or funding school or university costs. They have excellent long-term returns, low management charges and enable the investor to spread their risk.
If you invested £1,000 on behalf of a child at birth in the average investment trust, on their 18th birthday you could give them a cheque for £16,897. If you waited until they were 21, you could give them a cheque for £34,439 – an impressive start in life.
Your clients' children would have all the benefits of stockmarket investment while spreading the risk in 50 or more companies. In addition, all investment trust companies have boards of directors, independent of the managers, whose responsibility is to work on behalf of shareholders with the sole purpose of maximising value.
One of the ways in which boards can have a favourable influence is over charges. Last year, Fitzrovia International compared the total expense ratios of investment trusts with retail unit trusts and Oeics. As the size of the investment trusts increased, the TER dramatically decreased. Investment trusts with assets of more than £1bn had an average TER of only 0.46 per cent, whereas unit trusts and Oeics with assets of more than £1bn had an average TER of 1.32 per cent.
It is clear that lower charges mean more money remains invested and this can have an important impact on children's investments over the long term.
Children under age 18 are not able to hold company shares in their own name but an easy way round this is for the client to invest on their behalf in a way that they become the beneficial owners of the shares. Even though the shares will be registered in the client's name, you can include the child's initials alongside. This involves setting up a designated account and is a very simple way of holding shares in a bare trust.
Although your client will be the registered owner of the shares, the child is the beneficial owner and your client is obliged to hand over the assets when the child reaches 18. Until that time, your client is the trustee and is responsible for looking after the investment until the shares can be registered in the child's name. All the necessary paperwork for starting up this type of trust is usually available from your investment trust provider.
Children have their own personal tax allowance and, as long as the child's taxable income does not exceed the personal allowance (£4,385 for 2000/2001), there will be no income tax at all to pay on the income received. However, the income will be added to any other source of income received by the child such as wages from a part-time job. Children also have a capital gains tax allowance if profits are made on the disposal of the shares.
One of the most important questions is whether your client will have to pay tax on the child's income. This really depends on who is gifting the investment to the child and what their relationship is. If your clients are parents who have made an investment on the behalf of their child which generates an income of £100 or more a year, it is deemed to be part of their income and they will have to pay income tax on that income.
However, if your client is a grandparent, friend or other relation, the income tax situation is different. Any income generated by gifts made from those other than parents is treated as the child's.
Two financial problems for your clients are school fees and university expenses. Day schools can charge up to £7,300 a year and boarding schools can charge up to £15,000 a year to educate a child between the ages of 13 to 18 (source: Independent Schools Information Service). The introduction of tuition fees at universities has increased the burden.
During the 1999/2000 academic year, a student outside London spent on average £5,881 on tuition, rent, fuel, food, laundry, insurance, clothing, travel, books and leisure. For a student inside London, this figure spiralled to £7,192, according to the National Union of Students. To meet these expenses, most students would have taken out hefty loans of up to £3,635 outside London and up to £4,480 in London. However, there is still a shortfall between the loans and expenses.
From as little as £25 a month or a £250 lump sum, your clients can save via an investment trust saving scheme with no penalties for stopping or reducing contributions. If your clients save regularly, they can take advantage of the benefits of poundcost averaging, allowing them to buy more shares when prices are low. If you had invested £40 a month into the average global investment trust over the last 15 years, it would now be worth £20,905. The same amount invested in a building society over the last 15 years would be worth only £10,207.
Another useful way of providing cover for school or university expenses are zero-dividend preference shares. Despite their off-putting name, these offer a low-risk way of providing a fixed amount to meet future costs. Forming part of a split-capital investment trust, zeros have a fixed life span usually between five and 10 years. This means you can choose a number of zeros to provide amounts over successive years. They are also a way of using up your clients capital gains tax allowance, presently £7,200.
The typical annual return of zeros is around 7 to 8 per cent but can be as high as 12 per cent. They have proved very popular. The first zeros were introduced in 1987 and today the market capitalisation is over £3.3bn.
IFAs can now buy any investment trust for their clients through the Transact service and earn both initial and trail commission. The service can be accessed by post or telephone, as well as online, which is an advantage for many IFAs compared with the online-only fund supermarkets. In addition, IFAs can access any unit trust, Oeic or quoted equity through the service, providing the widest possible spread of investments.
The service provides Pep consolidation, Isas and personal pension wrappers as well as directly-held investments. The second year of the AITC's “its” campaign is now well underway and the advertising tells consumers to talk to their IFA about investment trusts. The Transact service and the “its” campaign provides IFAs with an incentive to recommend investment trusts.