I don’t have kids myself but I’ve noticed that some people do, and even more people are thinking of getting some. The masochists.
I’ve also noticed that people like their kids. A lot. They want to protect them from future harm.
And what better way to do that than to invest on their behalf from the moment the ink dries on the birth certificate?
Hey, this is a site about investing – this is how we show the love!
Besides, even I have two wonderful nieces, and I recently scoured the market to find the best Junior ISA (JISA) deal for them.
Setting pressie money to work towards their future seems like a much better gift than adding to the mound of colourful plastic tat that already surrounds them. More toys isn’t what they need.
Rather, a dollop of assets that can compound [1] for decades and buffer them against a retreating State and the competing future pressures of university fees [2], mortgages, and pension contributions [3] is giving them something they will be thankful for – even though I might not immediately see a smile on their little faces.
The question is how to invest for children to deliver the biggest bang for your bucks?
[4]
Asset allocation [5]
A friend of mine invested in a cautious fund for their newborn because an IFA explained that certain investments are risky while others are as gentle as Bagpuss. The last thing my friend wanted to do was risk her child’s future on a moonshot, so she went cautious: 40% equities, 60% bonds.
That sounds sensible, but it’s equities that typically drive returns, not bonds. Over multiple decades, portfolios that favour equities are most likely to deliver stronger results.
UK data is hard to come by, but in the US equities have beaten bonds 95% of the time over 20 year periods, and 99% of the time [6] over 30 years.
The little darlings can afford to play a waiting game. Their risk tolerance [7] is extremely high because you’re going to be providing life’s essentials for at least the first 20 years (and for much if not all of that time they won’t know or care about the stock market, anyway).
They’ll then enter the labour force and have decades of earnings [8] ahead of them.
In other words, they are rich [9] in human capital. They’ve got plenty of time to ride out a poor run for equities and to wait for them to come good.
For my nieces, I’ve gone for a 100% equity allocation. The expected returns [10] are higher and they can ignore the volatility.
Still you could sensibly decide that history doesn’t guarantee the future and you’d rather the portfolio was better diversified [11] with, say, a 20% allocation to bonds.
Also, if your chosen investment option means that your child will take over the account in 18 years or thereabouts, then you could gradually de-risk it [12] if you start from a very adventurous equity position.
The simplest, cheapest option is to use a low cost, global passive [13] vehicle like one of Vanguard’s LifeStrategy funds [14].
Such a fund is hugely diversified across global markets, is low maintenance, and automatically rebalances between asset classes.
Platform
You can manage the child’s investment yourself using a DIY online investing platform. Our broker comparison table [15] will guide you through the options.
The cheapest brokers for adults are worth looking at for the best kids’ deals, too.
- If you plan to make regular contributions, say monthly, and the fund is likely to remain below £32,000 for a long time, then look at Cavendish Online or Charles Stanley Direct.
- If you’re contributing regularly but operating above the £32,000 threshold, then check out iWeb and Interactive Investor.
It’s all about keeping your costs low so that your child’s fund benefits, as opposed to lining the pockets of the finance industry. A few quick calculations will show you why [16].
Now let’s look at how to invest for children in the most appropriate investing vehicles available.
Junior ISA (JISA)
You can contribute up to £9,000 annually on behalf of your child into a JISA [17].
This works very much like an adult ISA:
- Available in cash and stocks and shares flavours.
- Contributions grow free from income tax and capital gains tax.
The differences are:
- Mini-you can withdraw the money on their 18th birthday.
- If the JISA survives that existential threat, then it metamorphoses into an adult ISA.
- 16-17 year-old Young Apprentice types can take over the management of their JISA and put up to £20,000 of their own money into it, on top of your piffling four grand.
- A parent or guardian opens the account, but the child owns the money.
Children born after 3 January 2011 or those aged under 18 and without a Child Trust Fund (CTF) [18] can have a Junior ISA.
From April 2015, kiddiewinks who have a CTF can transfer it into a JISA.
CTFs are the forerunners of JISAs and are similar in the way that the Teletubbies aren’t a million miles from In The Night Garden.
The klaxon-blaring feature of both JISAs and CTFs is that your offspring can do whatever they like with the money from the age of 18.
If you’re at all worried that you may be creating the mother of all booze funds then you have some longer-term options for retaining control.
Your ISA
With today’s more generous allowances, there might be enough room in your ISA to tuck away a fund or a portion of one for the little guys.
The tax breaks remain the same but the assets are under your command. You can decide when to pay out the proceeds, or use them to maintain discipline, emotional blackmail – whatever.
The downside is that the money will lose its tax shielding once it leaves your ISA. You may also need to make legal provision to ensure the money is used as you intended in the event of death or divorce.
Child pensions
This one always makes me chuckle because it seems so absurd. Sadly though, today’s bonny babies will one day be washed-up wrinklies wise old birds.
Your children will, in all likelihood, need a retirement plan. And given our looming pension crises, worsening demographics, and the hard-wired inability to think ahead, you can scarcely choose a wiser gift than planting an acorn which will grow into a sturdy oak of a pension many years hence.
Even today, you can’t access your pension until age 55. By the time a newborn grows up the minimum age for withdrawal will probably be sixty-something.
Most likely they’ll have calmed down by then.
Chances are they’ll be toasting your 90th birthday and thanking you for the foresight that enabled them to benefit from the amazing potential of six decades of compounding equity returns.
That’s the vision, anyway. The concrete steps:
- Open a stakeholder pension or Child SIPP.
- Every £80 you put in is topped up to £100 by the Government’s 20% tax relief.
- Put in £2,880 per year to benefit from max tax relief and to hit the gross annual investment limit of £3,600.
- Anyone can contribute up to the £2,880 net maximum.
Take a look at Cavendish Online and Best Invest as platforms.
Put in £2,880 per year for the first 18 years, leave to compound until age 65 (assuming a 5% real return and 20% tax relief), and junior will be a millionaire [19].
Of course a million pounds won’t be worth a million by then but every little helps.
Junior investment accounts
A junior investment account is a taxable account that may be intended for a child but is held in your name.
In other words, you retain control for as long you like.
The tax situation is odd:
- If one parent contributes then the account is taxed on interest and dividends earned above £100 per year at that parent’s tax rate.
- If both parent’s contribute then the account can earn £200 income before being taxed at the highest earner’s rate.
- So if the contributors fall into the 20% income tax bracket then there won’t be any deduction from dividends because the requisite amount is already sheared off.
- Contributions from anyone else – including grandparents and other relatives – are not subject to the above restrictions.
In the latter instance, it’s the bairn’s tax rate that counts. They have a £12,500 personal allowance [20], like anyone else, so the tax bill is likely to be light unless you’ve sired a young Rockefeller.
Similarly, baby’s capital gains allowance of £12,300 per year should be enough to cope with most growth scenarios – and if it isn’t then they’re laughing anyway.
You could place this type of account or other assets into a trust. I’m not going to get into that subject here, but HMRC have kindly rustled up some guidance [21] for beginners.
Inheritance tax and gifting
Reducing inheritance tax (IHT) is a strong motive to sock away some money for the next generation sooner rather than later.
You can give away annually:
- Up to £3,000, known as the annual gift exemption (Plus a roll over from the previous year if you didn’t bestow the full amount).
- Up to £250 as a small gift to any number of people who didn’t benefit from your £3,000 giveaway. If you give somebody more than £250 then the exemption is lost from their whole gift.
- You can make IHT exempt regular payments (e.g. monthly savings contributions, birthdays, Christmas) as long as you have enough income left over to maintain your normal lifestyle. Sounds woolly? Very, but you can read more about it over on HMRC’s IHT pages [22].
- Any giveaways beyond the above will avoid inheritance tax if you manage to hang on for seven years after the gift date. Die before then though and, quite apart from upsetting everyone, you’ll potentially land them with an IHT tax bill. Selfish.
NS&I Children’s Bonds and Friendly Societies
If that all sounds a bit racy then you can invest tax-free in some cuddly Children’s Bonds [23] from the Treasury backed NS&I.
- This is a fixed interest 5-year savings bond.
- Parents, guardians, grandparents and even great-grand parents can pitch in.
- You can contribute £25 to £3,000 per child per issue.
- Interest is tax-free.
- Capital is 100% secure because NS&I is an arm of the UK Treasury.
- You can roll over the bonds every five years.
- The rugrat takes over at age 16.
You can also invest between £100 and £30,000 in premium bonds that handover when the nipper makes 18.
For completion’s sake, and just in case you’ve got any money left, you could look up Friendly Society tax-exempt plans. You can only pay in up to £300 a year but the investment can run tax-free for 25 years and is run by a Mutual.
How to invest for children with silly parents
Funnily enough, the only resistance I ran into when investing for my nieces was from adults who thought it was a little cold to deny the kids the instant gratification of unwrapping a pressie.
But actually, I think the only people who are reluctant to give up their kicks are adults who enjoy a little bribery.
My eldest niece totally understands saving and is well able to visualise the money as her ticket to a proper toy like her first car.
Most kids don’t suffer from a shortage of instant gratification. So it makes sense to put your money towards something that will make a real difference when life gets a little tougher.
“Time for bed,” said Zebedee
“Take it steady”, said The Accumulator