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
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's 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.