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Verity&#39s View

Given the zeal with which politicians love to bash the financial services industry, last week&#39s announcement on Baby Bonds carried a touch of irony.

Here were Tony Blair, Gordon Brown, Alistair Darling, David Blunkett gathered to say how they planned to end child poverty within a generation. Turns out they are handing over this Herculean task to those who on another day would be panned by politicians as the worst of the profiteers, enemies of the public interest, predators preying on the poor. This noble task, in another words, is being handed over to none other than the financial services industry.

In one respect, Labour&#39s big idea would be a big breakthrough. Never before has the Government given out taxpayer&#39s money as a lump sum to be invested rather than spent. It looks deceptively simple. Give every new-born child a lump sum, invest it and by the time they are 18 they will have a nice lump sum to spend. And relatives could chip in too.

But simple ideas like this have a nasty habit of turning complicated. Peps were “simply” tax-free equity investments with a lock-in period. Tessas were “simply” tax-free savings accounts with a long notice period. Isas were “simply” both of those mixed together, separately or in any combination (with no notice period). Personal pensions were “simply” a tax-efficient way to build up a lump sum for retirement.

Already, just days after the announcement, a few things about child trust funds are clear. The Government wants the resulting funds not to be squandered on beer, CDs and clothes at 18 but worthwhile things such as education and housing. With tuition fees and housing costs being what they are, the £800 which the Government proposes to give to the poorest children would have to grow substantially to be worth bothering about.

According to Brown, a child of poor parents whose grandparents chipped in £5 a month to a fund would end up with over £3,300. But to get to that figure, the Treasury&#39s used a projected return of 5 per cent over and above inflation.

To get anything like that return, the money would have to be invested in stockmarket-based products with ultra-low charges. Just as with stakeholder pensions, it is hard to see how this could be profitable for providers to offer that, especially with such tiny sums invested.

Even leaving this aside, the Treasury&#39s figures have the whiff of racy marketing. The FSA prescribes a mid-rate projection of 6 per cent for taxed products, including inflation of 2.5 per cent. In other words, a “prudent” adviser would project using a real rate of return of 3.5 per cent, not 5 per cent.

But I suppose child trust funds would have to grow tax-free, otherwise the grandparents might be better off investing in an Isa. So, the projection rate could be the untaxed mid-range one of 7 per cent or 4.5 per cent in real terms, which is not so horribly far off the Treasury&#39s estimate. But further complications creep in. The Treasury thinks relatives in poorer families would be put off chipping in to the child trust fund if their money had to sit there for 18 years. But if the product grew free of tax, the Revenue could not allow money to be withdrawn by the relatives while it grew, otherwise it could simply be abused as a surrogate way for adults to save tax-free – a sort of kiddie-Pep.

The money would have to be locked into an equity fund for 18 years. But then you would have to prevent taxpayers&#39 money being entrusted for 18 years to a provider that is good at attracting money cheaply but terrible at investing it. Should you allow people to switch investment houses to avoid that? Would you have lifestyle switching to guard against a stockmarket downturn when the child approached 18?

Prudential managing director Keith Bedell-Pearce has already said that the only way these products will work, the only way they can be cheap enough, is if they&#39re ultra-simple. But the only way they&#39ll be that simple is if considerations like the above are ignored. And that means both the taxpayer and the holder of the child trust fund will be taking risks.

Twenty-five years ago, another Labour Government had a similar, no less laudable aim. Except then it was not to abolish child poverty but pensioner poverty. It started as a simple idea that the Government would chip in to private pension schemes in a form of partnership with employers and/or insurers. These days, as every IFA knows, you do not get much more complicated than Serps and contracting out.

Let&#39s not make the same mistake again. If the Government really wants to invest in the futures of our young ones, I can think of a much simpler way. And don&#39t say it is too expensive because the Scots have already shown that it is not. Forget the idea of creating yet another financial product with all the attendant headache and hassle. Just scrap tuition fees.


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