Make Your Kid Rich With A Child Trust Fund

Child Trust Funds are a relatively new innovation. They were first introduced by the government in 2005 and entitle every child born on or after 1 September 2002 to a voucher worth £250.

These vouchers can be put into a Child Trust Fund account where they will grow, free of tax, until the child turns 18. An additional top-up payment of £250 is made on the child’s 7th birthday. Children in low-income families, defined as those who receive Child Tax Credit, receive payments of £500 rather than £250. Almost one third of children are reckoned to receive this additional top up.

What do you do with the voucher?

You can present the voucher to one of around 50 Child Trust providers. They are listed on the very useful Child Trust Fund website. As well as choosing a provider you also have to choose one of three basic types of Child Trust Fund. These are stakeholder, cash and shares.

Stakeholders are the most popular by far accounting for three-quarters of all Child Trust Funds. Here your child’s money is invested in the stock market. In order to reduce risk, the money is gradually moved into cash after they reach the age of 13, so if the stock market was to fall in the last few years of the account the damage will be limited. The maximum a company can charge for a stakeholder Child Trust Fund is 1.5% a year.

If you want to invest ethically, then several companies provide an ethical stakeholder version of the Child Trust Fund. There is also a Sharia compliant fund.

Cash Child Trust Funds are the second most popular choice, accounting for one-fifth of all accounts. Here the money is put into a savings account. It’s the safest of the three options and the rates of interest available are comparable to ordinary savings accounts although watch out for high bonus rates that only apply for the first year or so.

Some cash Child Trust Funds guarantee that their interest rates won’t drop below the base rate for a certain number of years. Nevertheless it pays to keep an eye on the rate you’re getting. You’re perfectly entitled to move the money to another Child Trust Fund if you’re not getting a good deal.

Share Child Trust Funds are the least popular option and the choice of only one in twenty people opening a Child Trust Fund. Here you get to choose an investment funds or individual shares. There are no official limits to the charges on these accounts so check to see what you have to pay when you buy and sell investments. However, you should be able to invest much more cheaply than the 1.5% limit imposed on Stakeholder accounts.

This last type of Child Trust Funds is the highest risk but also provides the possibility of the biggest gains. Over long periods, such as the 18 years a Child Trust Fund lasts, shares have traditionally produce much better returns than cash. If you’re comfortable picking an investment then this type of Child Trust Fund is probably the way to go. If you’re not, but still want to aim for a higher return than you can get from cash, then a stakeholder account makes more sense.

Each Child Trust Fund voucher has an expiry date. If you haven’t opened a Child Trust Fund by this date then the money is automatically invested into a stakeholder account on your behalf. The government will choose a provider for you from a shortlist of about a dozen. Amazingly, almost of a quarter of parents don’t choose a Child Trust Fund provider and end up going down this route.

Can you put more money in?

Anyone including parents, grandparents plus favourite uncles and aunts can top-up a Child Trust Fund. The maximum amount per Child Trust Fund per year is £1,200. The years run from your child’s birthday to the next and unfortunately you can’t add extra money if you’ve missed out in previous years. So if you only put in £900 in the first year for example, you can’t put in £1,500 in the second to catch up.

£1,200 a year may not sound like much. Adults can put six times as much each year into an ISA. Yet Child Trust Funds can still build up into a significant sum by the time your child turns 18.

Children who receive the full amount each year and get an annual return of 7% could see their Child Trust Fund valued at around £36,000 when it matures. While inflation will reduce the spending power of this money, it’s still likely to be a significant sum that could fund a deposit for a house or pay off university debts. Indeed, it’s impossible to stress just how important a sizable sum of money can be at this age if it’s used wisely. It can save your child from starting their adult life in debt, which is a problem we see so much of at the moment.

However, it seems that few Child Trust Funds will reach their full potential. 75% of parents have not put any additional money in and a further 18% put in £300 a year or less. Only 1% of parents put in the full amount of £1,200 a year. Those choosing Share accounts tend to be much more likely to put in additional contributions to their Child Trust Funds. There is also a minimum contribution level of £10 for stakeholder accounts although some will accept contributions for less than this amount.

What happens when your child turns 18?

One of the reasons for the low level of additional contributions into Child Trust Funds is the perfectly valid worry that your child could go out on their 18th birthday and blow the lot in one go. They are legally entitled to do as they wish with the money at this point.

However, many parents see these funds as an opportunity to teach their kids about financial matters. From the age of 16, children are allowed to decide how their fund should be managed. Also the government has confirmed that all maturing Child Trust Funds can be rolled over into ISAs, thus preserving their tax-free status for as long as the money remains in the account. This is excellent news but it will be a long time before we see how many people take advantage of it!