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Stake in the future

I want to save money for my grandchildren but I am concerned at the

relatively poor returns from bank and building society accounts. What

alternatives do I have?

Investing some money is an extremely good way of giving a child a head

start in life. This investment can be in the form of a one-off lump sum or

regular savings.

The most important factors in your decision will be the level of risk you

wish to take with the money, the tax-efficiency of the investment for you

and your grandchildren and level of charges applied.

As you are aware, most people put their savings into high-street deposit

accounts, either instant-access savings accounts or 90-day accounts paying

higher levels of interest. But in the current environment of low interest

rates, the returns from these cash holdings are becoming less and less

attractive. They are still ideal as a home for short-term money but, over

the timescale you are looking at, they are not ideal.

The next step up is National Savings Children&#39s Bonus Bonds. These are

tax-free and provide a guaranteed fixed compound interest rate over the

first five years. We are currently on Issue W offering 4.6 per cent

compound for the first five years.

The downside is that you are limited to investing £1,000 per issue

for each child. More important is the outlook for National Savings products

as a whole. The Red Book produced after each Budget reveals that the sales

target for National Savings for the next 12 months is -£3bn. To

achieve this target, returns will have to drop – probably more

significantly than interest rates.

The one glimmer of hope for National Savings is for the Government to

embark on a huge public spending programme, forcing it to borrow money

using instruments such as National Savings.

Friendly society plans have traditionally been a popular form of

tax-efficient savings for children and grandchildren. As long as the

investment is held for a minimum of 10 years, the proceeds are free of tax

in the hands of the child or grandchild. Throughout the investment term,

the fund is free of income and capital gains taxes.

Again, there are drawbacks. First, you are limited to a maximum saving of

£25 a month. These plans also have high charges relative to other

forms of savings and, unlike the other options already mentioned, the

capital is not protected. Friendly society plans offer you the first level

of investment that is linked to equity performance – in other words, fund

values can fall as well as rise.

Moving up the scale of risk we reach collective investments – unit trusts,

Oeics and investment trusts. Historically, these types of savings plan have

produced the best long-term returns although they are definitely not for

short-term or risk-averse investors.

An adult purchases these investments in their own name but designates the

account for the child. Any income produced will be assessed against the

child if the investment was made by anyone other than the parents. It is

important to note that, for parental gifts or savings, the removal of the

bare trust loophole since March 1999 means any income above £100 a

year produced by the investment will be taxed as income of the parent.

There are thousands of funds to choose from, ranging in risk from low to

extremely high. It makes sense to invest in growth-orientated funds as

children have the same annual capital gains exemption as adults.

Popular investment trust funds for children include those investing

exclusively in zero-dividend preference shares. These are lower risk than

capital shares because they produce a known return. For unit trusts and

Oeics, international portfolio funds are used extensively. By nature of

these being longer-term plans, a geographical spread of equities provides a

balanced approach at a medium risk.

Some of these investments will accept as little as a £250 lump sum or

£25 a month although the norm is higher than this. Please remember

that inheritance tax needs to taken into account when the total gifts

exceed the annual exemption of £3,000.

The newest alternative for saving for children or grandchildren is a

long-term option. Stakeholder pensions allow up to £3,600 a year to be

invested for up to five years for someone who is not in employment. It is

possible to invest for a child or grandchild for this period.

This form of saving is very tax-efficient because the premium gains tax

relief as well as the fund growing virtually tax-free. The main drawback is

that the child cannot access this money until reaching 50.

In the climate of a continued reduction in the real value of state

retirement provision, you would be providing your grandchildren with a

cornerstone to their long-term savings.

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