MONEY COMMENT
Making Your Kids Pay Their Way

By Cliff D'Arcy
June 12, 2003

As the parent of a young child (with another on the way), I'm often asked for advice by friends, family and Fools on how to save for children. It's hardly surprising that this is one of the most common questions we face, when you bear in mind that almost 2,000 babies are born in the UK every single day.

First of all, you have to have money to save - and a lot of people claim they don't, as you can see in this new savings survey. However, you might be surprised at how much money you can free up with a more disciplined approach to budgeting, a shuffle of your credit cards, and a move for your mortgage. (See this article on managing your money).

Furthermore, make sure that you claim your free money from the government and also that you're keeping your tax bill to a minimum. Once you've done this, you can move onto deciding what to save and where – you'd be amazed how little you need to begin.

For the ultra-cautious

If the warning "shares can go down as well as up" fills you with dread, you might well decide - as many parents do - to put money on deposit for your children. Here's how to get the most out of your young un's savings account:

1. Open two accounts: one for money from parents and the other for cash from everyone else. Do this because children can only earn £100 a year in interest from capital given by a parent. So, keep your money separate from the rest, in case the taxman comes snooping. When your child earns over £200 a year in interest from parental capital of, say, £5,000 or more, you face a tax problem!
2. Good news: interest earned from cash gifts from anyone else isn't taxed at all (assuming your child doesn't earn more than the annual personal tax-free allowance).
3. Complete form R85, which will allow your child to earn interest tax-free (without the usual 20% savings tax being deducted).
4. Don't be swayed by gimmicks; choose an account with a competitive rate of interest – aim for 4% or more.

Saving £75 a month (about £10 more than the rate of Child Benefit) over 18 years at 4% interest (call it 1.5% after inflation) will build up a lump sum of £18,590 in today's money. However, to amass a sum of this size, you'll probably need to save in your name (perhaps in a cash mini-ISA) in order to avoid the interest being taxed.

For investing Fools

If you've spent much time browsing the Fool, you'll know that we're big fans of investing in shares. Over the eighteen-year horizon from birth until university, shares are likely to outperform all other mainstream investments.

One of the cheapest ways to invest in shares in via a low-charging index tracker. We think these are very Foolish investments indeed, being cheap, flexible and easy to understand. Another low-cost savings scheme is an investment trust (choose from five different IT plans here).

Also, you can use a tax-free ISA wrapper to keep your money out of the taxman's hands (as long as it's in your name - kids can't have ISAs until they turn 18).

If you save £75 a month in a shares ISA over 18 years, and earn 6% after charges and inflation, guess how much you'll have? Well, you'll have saved a total of £16,200 but your fund will have grown to £28,711 in today's money – over £10,000 more than in our savings example (see our savings calculator).

PS: We found yet another fiver in the street last week!

More: Investing For Children | How To Make Your Kids Rich | Turning Small Change Into Big Bucks