Other routes to take after child trust fund hits end of the line

AFTER the widely expected axe finally fell on child trust funds (CTFs) this week, parents wanting to put money aside for their offspring are on the search for new tax-efficient savings options.

The new government announced that CTF vouchers would be cut from 250 (500 for low-income families) to 50 (100) in August before the last vouchers are sent out on Hogmanay. Parents getting a CTF voucher before 1 January, 2011 will be able to use it and benefit from the annual allowance. Those with vouchers yet to be invested, or set to receive one during the remainder of 2010, will still have 12 months in which to use them.

David White, chief executive of The Children's Mutual, said he was staggered by the announcement: "Today's parents are paying out an average of 30,000 to fund their children between the ages of 18 to 30, and these costs are only expected to rise for families of tomorrow. CTF-holding children now hold a unique asset that others will not."

Figures from the Tax Incentivised Savings Association show that families are making additional contributions of 14.4 million to over 640,000 CTF accounts at an average of 22.50 a month.

Contributions into CTFs already open will continue to be tax-free, with parents, friends and family able to contribute up to 1,200 a year.

However the withdrawal of government support means some CTF providers are likely to leave the market or reduce the interest paid on their products.

The Association of Investment Companies (AIC) has called on the government to allow new parents to set up CTFs even after government contributions end. Ian Sayers, director general of the AIC, said: "Allowing new accounts to be set up would mean that parents who have already opened an account for an existing child can carry on the habit of saving for their later arriving brothers and sisters. It will also provide a stimulus for new parents to save for their child's future and hopefully develop a savings habit."

The good news is that, post-CTFs, saving for children can still be tax-efficient, up to a limit. Parents can invest an unlimited amount for their children each year, but if the money earns more than 100 in interest over the year it is taxed at the parent's rate. Other relatives can also gift as much as they like and the returns are tax-free provided the interest is below the annual personal allowance for children of 6,475.

The demise of CTFs may hit the level of child savings in the UK, but for parents and other relatives wanting to invest for children there are several ways of doing so outside CTFs.

• CASH

CTFs are just one component of the child savings market. Most banks and building societies have accounts marketed as child savings, although there are currently just five savings accounts available that mirror CTFs in that the fund can't be accessed until the child is 18. They include the best-buy Foxley Fund from Chorley & District Building Society, paying 2.9 per cent, and Scottish Building Society's Young Scotsaver, paying 1.65 per cent.

Elsewhere, National Savings & Investments offers children's bonus bonds, which are free of both CGT and income tax. However, the current bond, which has a five-year term, pays a fixed rate of just 2.5 per cent, according to Michelle Slade at Moneyfacts.

"When you consider that Clydesdale Bank has a similar five-year bond paying 4.45 per cent, its doesn't look quite so attractive," said Slade.

Another option is a friendly society's tax-exempt savings plan. Up to 25 a month or 270 a year can be invested annually and the growth builds up without tax deducted. For example, the Scottish Friendly child bond is a tax-free ten-year savings plan that invests in the group's with-profits fund. The plan can accept a single lump sum premium of 2,340 for a ten-year period, which invests 270 a year into the bond.

• EQUITIES

The long-term nature of equity-based investing makes it ideal for child savings because investments held for 18 years or more allow for short-term volatility to be smoothed out. The low cost of investment trusts makes them particularly suitable for child savings, as the lengthy period of investment also means the cost of investing can add up significantly and eat into the eventual returns.

Investment trusts with dedicated savings plans include Baillie Gifford, Witan – with its Jump plan – F&C, Scottish Investment Trust, with "Stockplan – a flying start", and Alliance Trust, with most allowing monthly investments of as little as 25 or 30. Most are global trusts spreading the investment across different regions and sectors.

The ability to invest tax-efficiently through a bare trust or a designated account is a further advantage of child savings plans. With bare trusts, for example, the investment remains outside the parental estate for inheritance tax (IHT) purposes and the proceeds are CGT-exempt, as they are treated as belonging to the child. Most unit and investment trusts can be designated for children, whereby the income is treated as belonging to the child and the assets are transferred to the beneficiary at 18.

Children cannot hold a unit or investment trust until they are 18, but adults can open them and add the child's initials to the name of the account holder.