Child trust fund shortfalls likely to be short-term woe

Published on Friday 16 January 2009 18:19

PARENTS investing for their children have been urged not to panic after having thousands wiped off the value of the money they put aside.

It is estimated that market turbulence in the last year has wiped off nearly a third of the value of child trust funds (CTFs) invested in stocks and shares. Parents receiving their annual statements will be alarmed to find that, at present, the returns on their contributions are either minimal or non-existent. With an investment time-frame of 18 years, however, parents have time on their side to ride out the peaks and troughs of stock market investing.

CTFs were introduced in 2005 by the government, which gave children born between 1 September 2002 and 5 April 2005 a lump sum of 256 ( 512 for families in receipt of Child Tax Credit). Those born after 5 April 2005 receive a voucher for 250 (or 500) which their parents have to invest into a CTF. The government pays an additional amount into a child's CTF when they turn seven. Contributions of up to 1,200 a year can be made by parents, family and friends and the money cannot be withdrawn until the child turns 18.

There are three options for families putting money in CTFs for their children: a cash savings account in a bank or building society; a stocks and shares account, where the money is invested in the stockmarket; and a stakeholder account, where the money is invested in stocks and shares until the child hits 13, then moving into lower risk assets. As the government's default option, the latter accounts for the majority of CTFs .

Over four million CTFs have been opened since 2005, with three million opened by parents and the remainder opened automatically by the government. Interestingly, take-up has improved as the economy has declined, according to leading CTF provider The Children's Mutual, which reported a 16 per cent increase last year in the number of CTF accounts opened.

Those who have invested in stock market-based CTFs have been hit hard by the market downturn, with some funds showing negative returns since they were opened.

But while there have been reports of parents transferring out of CTFs, the main providers say that has not been the case. "I can see why parents would feel uncomfortable right now, but they realise that the accounts are taken out for babies and paid out at the end of it to adults," said Kate Baker, head of savings and investments at Family Investments. "They have lots of time for growth and understand that any losses over the current period are not permanent."

With another 11 years before the first CTFs mature, time is on the side of those parents hoping stock markets will provide the best returns over the longer term, pointed out Neil Lovatt, sales and marketing director at Scottish Friendly. "Although stock market investors have seen the value of their CTFs fall, it is important to remember that their portfolios are very much in their infancy. Over time, the more regular investments they add, the more their CTF can benefit from growth opportunities."

Lovatt backed this up by analysing the performance of a regular 25-a-month investment over more than 200 18-year periods since January 1973, comparing the returns from a base rate tracker fund and from an FTSE All share tracker fund that moves into cash in the last five years, like a stakeholder CTF. The analysis revealed that the FTSE-based fund beat the base-rate tracker in every 18-year period.

"What is interesting about the figures is that, during these 18-year periods, most investors experienced some form of short-term stock market downturn," said Lovatt. "But had they stuck the course they always ended up on top. It emphasises that in the past it has paid to view a long-term investment over many years and not a few months."

If you're looking to put money aside for your children or grandchildren, CTFs are not the only way to do it. Although CTFs benefit from tax advantages, some parents may be deterred by the fact that the money is locked away until the child turns 18, at which point it passes directly to the beneficiary. "However parents can, and always have, been able to gain the tax-advantages of a CTF by using a child's capital gains tax allowance," said Lovatt. "This allows an annual profit of currently 9,600 each year without paying any tax. With a little bit of careful planning this can enable parents to save substantial sums for their children."

Oran's more prepared than many youngsters

DONNA-LOUISE Ritson's youngest may be just four days old, but the child's financial foundations will be established early in life.

Donna-Louise, 34, of Howgate in Midlothian, took out a child trust fund (CTF) after the birth of her first child, Oran, in 2007, and now plans to take out another one for the new addition to the family.

Donna-Louise and her husband, Simon, currently save 25 a month into the CTF and another 10 a month into a Scottish Friendly Child Bond, a tax-free ten-year with-profits investment.

"Investing a little each month enables us to build a financial future for our children," she explained. "We can help our children towards the best financial start in life by investing for them at a young age, which has always been of great importance to myself and my husband."

As the CTF can be topped up by up to 1,200 each year, the savings can be boosted at any point by further contributions to the fund. "It gives us peace of mind to know our children will have an amount to rely on, as we don't know what the future holds for any of us," she continued. "And if things go well, we can always add to the funds."