The government will soon make the first top-up payments for CTFs.
Next week will see the start of top-up payments for Child Trust Funds (CTFs) as the first children to benefit from this scheme turn seven. The standard top-up is £250, with low-income families getting £500. In order to qualify, the child must be born on or after 1 September 2002, in receipt of Child Benefit, have a CTF account and be living in the UK on their seventh birthday.
But what is a Child Trust Fund, and what should you do with the money? The first question is easy (and, I reckon, so is the second, but more of that shortly).
The government has published its own web site to explain the details, but a Child Trust fund is essentially just a long-term savings account for children, and any money deposited in the account can be withdrawn by the child (and by non-one else) when they reach the age of 18. And as the accounts are aimed at providing a small nest egg to help children embark on their adult lives, no money can be taken out at all before then.
There are a few sweeteners added too.
It's all tax-free
Firstly, and most importantly, all gains made in the account are tax-free. Now, not paying tax might not sound like much, as children generally don't earn enough to pay tax anyway, but compounded over 18 years, you might be surprised how large a modest investment can become.
Secondly, up to £1,200 a year can be added to the account, from any family or friends, and it all falls under the tax-free umbrella. So, it's a perfect way to put away a few bob at regular intervals for your kids, and a great place for them to save some of their birthday and Christmas money over the years.
And, as the final sweetener, the government starts the account with a £250 (or £500) voucher. As mentioned earlier, they contribute the same amount again when the child reaches the age of seven.
But where should you save the money?
Cash or shares?
There are actually three types of CTF, and you can choose to save all the money as cash, earning whatever interest the banks are paying, put the money into a share-based investment, or a mixture of the two. The third option, known as a stakeholder account, starts with the money in shares but moves it gradually to cash after the child's 13th birthday.
A cash savings account is great for stashing away short-term money, like cash you might need in the next few years. But as a long term investment, cash in the bank is a very poor performer over the long term.
The middling option might sound like a sensible way to start reducing risk when the time approaches for the child to want the money for something sensible, like education or a house deposit (and hopefully not for a flash car or fancy holidays). But as you can switch the type of account you hold whenever you want, you can shift money yourself if need be.
Shares are best
So of the three, I would strongly favour a share-based investment. (Interestingly, it's the least popular option of the three -- only around 5% of CTFs are share accounts, some 20% are cash and 75% are stakeholders.)
Specifically I'd go for an index tracker fund that invests the money across all of the shares in a specific stock market index (usually the FTSE-100 or the FTSE All Share -- there really isn't much difference). Index trackers usually levy very low charges, and the CTF site has details of which providers offer which types of account -- so what you'd need to do is contact suppliers of "non-stakeholder shares" accounts and compare their tracker investments.
You might think that's madness, with shares having suffered their worst 10-year period since the thirties. But in reality, such decades are extremely rare, and the Barclays Capital Equity Gilt Study has shown that shares have outperformed cash for 92% of all 10-year periods since 1900 -- and having just had a stinker, what's the chance of the next decade also being a bad one? Further, of all 18-year periods studied, shares beat cash 99% of the time, so over the duration of your child's CTF, a share-based investment is likely to beat a cash savings account hands-down.
What's it likely to be worth? If you just invest the two lots of £250 from the government, and contribute, say, £20 a month (which is a lot less than the maximum allowed), and you manage an annual return of 6% (which has been suggested as a sustainable long-term likely return from shares going forward), your child will end up with around £9,500 as an 18th birthday bonus.
Even better though would be to take advantage of the fact that you can roll the CTF account into an ISA, so that your investments can continue to grow free of tax. Come 2020, it will be interesting to see just how many take this option.
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