A Junior ISA provides a tax-free way to save for your children’s future. Since their introduction in 2011, they have become quite popular among parents and guardians wanting to give their children a financial head start.
However, according to new research, parents who have been saving for their children in a junior cash ISA may have collectively missed out on up to £13.5 billion in potential returns over the last decade. Here’s the lowdown.
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How does a junior ISA work?
A parent or guardian can open a junior ISA (JISA) for a child under the age of 18. You can currently save up to £9,000 in a junior ISA each tax year.
The funds in the account belong to the child. However, they’ll only be able to access the money when they are 18. That said, they can begin managing the account on their own once they reach the age of 16.
There are two main types of junior ISA:
- Junior cash ISA – essentially a savings account whereby you earn a fixed rate of return on your savings.
- Junior stocks and shares ISA – the money in the ISA is invested in the stock market and the return is determined by the performance of the investments.
The returns from both types of junior ISA are completely tax free.
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Why are parents losing out by investing in a junior cash ISA?
According to a new study by Scottish Friendly and the Centre for Economics and Business Research, parents who used the ‘stocks and shares’ version of the junior ISA would have earned as much as £32,300 more than those who saved in cash.
The research shows that cash JISA holders who maxed out their annual allowance every year since 2011 would have built up a pot worth £52,200 after depositing £44,800.
In comparison, those who maxed out their allowance with investments into the MSCI World Index, a global equity fund through a stocks and shares JISA would have accrued a total of £84,500 – that’s £32,300 more. This is based on an average annual return of 6.5%, taking fees into account. This return rate is more than four times the 1.53% rate of a cash JISA over the same period.
In total, cash JISA holders have missed out on almost £13.5 billion in potential returns.
Why are parents investing in cash instead of stocks and shares JISAs?
Despite the fact that stocks and shares JISAs hold the potential for greater returns, cash JISAs are still the more popular option among parents. For example, the number of cash JISA holders in 2019/2020 was 706,000, while the number of stocks and shares JISA holders was just 317,000.
Parents cite several reasons for preferring cash JISAs to stocks and shares JISAs. Almost a third (31%) felt that a cash JISA was easier to manage, and 27% thought that their money was more secure in a cash JISA. Meanwhile, 27% felt that setting up a cash JISA was easier than setting up a stocks and shares JISA.
How can you reduce the risk of losing money in a stocks and share JISA?
Over the long term, the returns generated by stocks and shares ISAs have outperformed cash savings. However, stocks can be volatile, which is one of the main reasons parents avoid them.
As Jill Mackay, head of marketing at Scottish Friendly, explains, “Everyone wants the best for their child when it comes to building a nest egg, so it’s understandable that many of us are tempted by a more cautious approach.”
Nonetheless, it is important not to let fear prevent you from taking advantage of the opportunity to build a much larger financial nest egg for your child.
If you are concerned about losing money, one of the best ways to address this is by diversifying your investments. That means spreading your investments across a range of companies, industries, and asset classes so that if one of them suffers a negative impact, your portfolio will only take a minor hit.
Additionally, with a stocks and shares JISA, you can reduce the level of risk as the child approaches the age of 18. For example, you can gradually reduce your exposure to stocks over time and begin investing more of your money in safer assets such as bonds. As a result, in the event of something unexpected, such as a stock market crash, the portfolio will not lose as much value.
