Investing for the children’s future? Don’t be afraid of going to the market

Junior Isas have reached their third birthday, but cautious parents could be missing out on thousands of pounds for their children as three-quarters have chosen to invest in cash accounts rather than in the stock market.

Junior Isas, launched on 1 November 2011 to replace Child Trust Funds (CTFs) which were introduced by the Labour in 2005 as a way of encouraging parents to save for their children and included a government payout. Only those born on or after 3 January 2011 or before 1 September 2002 (when they became eligible for CTFs) are eligible for Junior Isas.

Around 800,000 Junior Isas have been opened so far, but almost 75% are invested in cash, according to figures from HMRC. This is despite the fact that during the same period many savers moved money into shares or other higher-risk investments as the interest paid on savings accounts has festered at record low levels.

“Cash is frankly a dreadful place to invest for the long term, as the real value will be steadily depleted by the impact of inflation,” says Jason Hollands, managing director at financial planners Tilney Bestinvest.

Many parents will have taken the decision to invest in cash because they do not want to take a risk with money invested for their children – and the rates are not as bad as on most standard savings accounts. Others, however, will have invested in cash perhaps because they have no previous experience of the stock market.

This could then explain why money originally paid into CTFs is three-quarters invested in stakeholder accounts – low-risk share-based accounts that were, crucially, the default investment allocated to people who didn’t want to pay in the government cash themselves.

Ironically, by doing nothing, those parents may well end up with a larger pot of money than those who have chosen to invest their Junior Isa money into a cash account.

Equities or cash?

Where to invest Junior Isa money is not just an important decision for those who currently hold one, or are expecting a child, but also to the parents of more than six million children with money held in CTFs, which currently cannot be transferred into Junior Isas - but the government said at the end of last year that, subject to legislation, the first transfers should be possible from April 2015.

Many parents will want to take this route as, since CTF accounts stopped being sold, providers have focused their attention on Junior Isas, leaving those with CTFs with less investment choice and steeper charges.

Financial advisers are sometimes accused of a vested interest when it comes to pushing people towards stock markets, but the potential returns over 18 years cannot be ignored.

“These last three years have seen extraordinarily strong returns on developed world stock markets, with the UK’s FTSE All-Share Index delivering a total return of 48% and America’s S&P 500 Index up 79%. Those who invested in stocks and shares Junior Isas three years ago will be way ahead of those who chose cash,” says Hollands. “While returns on equities over the next few years may not be at the stellar levels of the last three years, we continue to believe equities offer considerably greater potential than cash.”

Alice Gibson, a hospital doctor, and her husband Matthew Paterson, who is in the navy, have chosen to invest in stocks and shares Junior Isas for their children, Clementine, two, and Wilfred, six weeks, in the hope of decent long-term returns.

Gibson, who lives in Calvert, Buckinghamshire, said: “When I was 18 my mother presented me with a Post Office savings cheque which was enough for me to buy a second-hand car and some other bits and pieces.

“It made me want to give some money to my children too, so that when they get to 18 they will be able to have some either for university fees, or whatever else they might need.”

The couple pay from £50 up to £150 a month into their Junior Isas which goes into Bestinvest’s Aggressive Multi-Asset portfolio. This invests in around 20 funds. Gibson said: “I have a limited knowledge of investments but over an 18-year period I’m confident that stocks and shares should provide better returns than if we’d put the money in a cash account.”

The equity options

When it comes to where to invest, advisers are naturally divided. Danny Cox, of advisers Hargreaves Lansdown recommends the Invesco Perpetual High Income and the First State Asia Pacific Leader funds, which have returned 44.6% and 35.7% respectively over the past three years. Hargreaves Lansdown charges 0.87% and 0.80% to hold these funds in its Junior Isa.

Many platforms offer access to more than 2,500 funds. “Among funds held by our Junior Isa investors, the top performer has been the Scottish Mortgage Investment Trust, which is up 98% over three years,” says Hollands.

Someone who invested the maximum annual Junior Isa allowance in this trust each year since the accounts launched (£3,600 in November 2011, £3,600 in November 2012, and £3,720 in November 2013), would be sitting on a fund worth £17,501, assuming dividends were reinvested. “That’s a return of £6,580 across the three years of contributions and you’d be able to invest a further £4,000 this year.”

Tilney BestInvest charges a 0.4% account fee for Junior Isas, and on investment trusts there is also a dealing fee of £7.50 per trade.

Patrick Connolly, of Chase de Vere, suggested the Witan Investment Trust, available as the Jump Junior ISA and Jump CTF: “This should provide consistent, rather than spectacular, long-term returns, what most people look for when saving for children. However, it charges a fixed annual management fee of £30 a year, so is most suitable for investments over £3,000.”

The cash options

Although stocks and shares usually offer higher returns than cash accounts over the long term, many parents prefer to stick with cash because they have a low appetite for risk. And perhaps some may worry about the consequences of maximising returns.

Junior Isas convert to adult Isas at age 18 when ownership is passed to the child who can cash it in or continue to invest as they choose. “This could mean that money put aside for university fees or property deposits could potentially be squandered on exotic holidays and fast cars,” says Connolly.

Interest rates on Junior Isas are currently marginally higher than their CTF equivalents. According to comparison website savingschampion.co.uk, the best rate on a cash CTF account is 3% from the Yorkshire building society. Halifax currently offers the market-leading cash Junior Isa, which pays 4% tax free for any child whose parent also holds a cash Isa with them. The rate falls to 3% if they don’t. Other competitive Junior Isas include Nationwide’s Smart Junior Isa and Coventry building society’s Junior Cash Isa, both paying 3.25%.

“The main advantage of the Junior cash Isa or CTF over a regular child’s savings account is that parents can contribute without being affected by tax rules that limit interest on gifts from parents to less than £100 a year, per parent,” says Susan Hannums, of savings website Savings Champion.

“These rules mean that if money given to a child by a parent outside a Junior Isa or CTF earns gross interest of more than £100 in any tax year, the parent is taxed on all the interest. At a rate of around 3%, a parent would fall foul of this rule on savings of about £3,300, and as the amount saved increases over time it could have a significant impact.”

KNOW THE RULES

■ Only those with parental responsibility can open a Junior Isa up until the age of 16. At 16 or 17 a child can open their own Junior Isa.

■ Your child cannot get a Junior Isa if they were eligible for a CTF. However, those with a CTF should be able to transfer any money into one in six months’ time

■ Although it will not be possible to move money in cash CTF accounts into Junior cash Isas until next April, you can still move into other cash CTF accounts now, provided they accept transfers. Similarly Junior cash Isa account holders can switch into other Junior cash Isas in order to earn higher returns

■ You can invest up to £4,000 a year in cash, stocks and shares or a combination of both in any tax year. If you want to invest in a mix of both, these do not have to be operated by the same provider but you can’t breach the £4,000k limit overall.

■ Your child cannot access the money until they are 18 unless they are terminally ill. If your child dies before they are 18, the money will normally transfer to you unless your child has married.