How you can build a nest egg for your child
Q: I'd like to build up some savings for my three-year-old daughter for when she turns 21.
I have an initial £1,000 lump sum, which I can follow with monthly contributions of £350, and possibly further lump sums.
What are the best options for tax-free investing? I was considering a FTSE tracker fund. I'd also like the investment to be in her name, if possible.
A: Patrick Connolly is a certified financial planner for AWD Chase de Vere.
With high inflation and historically low interest rates, you need to consider an alternative to a deposit account. You can best achieve long-term saving through collective funds, such as unit trusts, OEICs or investment trusts, where investors pool their capital together within a professionally managed single fund.
For very modest levels of saving, a single fund is appropriate, but for the size of monthly contribution you're considering I advise a blend of funds, in order to create diversification and a balanced portfolio.
The first option would be to maximise the funding into your daughter's child trust fund (which is no longer available to new babies), as you can invest up to £1,200 into it each year. The CTF is also tax-free so there's no income tax deducted from interest or dividends, nor any capital gains tax liability when money is withdrawn.
However, the savings will be available to your daughter once she reaches 18. Although there's no requirement for her to encash the plan then, she'll have full access to the capital.
If you feel that your daughter should be denied access to her savings until she reaches 21, you need to think about an alternative approach. You could consider setting up a trust. This should be drafted by a solicitor.
A trust will lay out clearly who the beneficiary is and at what age they'll be entitled to the trust fund.
A minimum of two trustees are required - these are normally the parents. The trustees oversee the investments and contributions into the trust, giving them full control over it.
Again, you can use collective funds, as these can be held within the trust until your daughter is 21.
To avoid incurring any trustee taxation, the investments can be assigned to your daughter's ownership upon her reaching 21. After that, any encashment can be managed against her capital gains tax allowance, which will provide tax-free returns.
To start with, I recommend the Fidelity Moneybuilder funds, as they provide good value. There's no initial charge and they give sufficient choice to enable you to create a balanced portfolio.
Moneybuilder Balanced invests between fixed-interest and UK shares, while Moneybuilder Global provides exposure to international stockmarkets. Together they provide a good compromise between risk and return over the medium to long term.
Open-ended investment companies are hybrid investment funds that have some of the features of an investment trust and some of a unit trust. Like an investment trust, an Oeic issues shares but, unlike an investment trust which has a fixed number of shares in issue, like a unit trust, the fund manager of an Oeic can create and redeem (buy back and cancel) shares subject to demand, so new shares are created for investors who want to buy and the Oeic buys back shares from investors who want to sell. Also, Oeic pricing is easier to understand than unit trusts as Oeics only have one price to buy or sell (unit trusts have one price to buy the unit and another lower price when selling it back to the fund).
An increase in the general level of prices that persists over a period of time. The inflation rate is a measure of the average change over a period, usually 12 months. If inflation is up 4%, this means the price of products and services is 4% higher than a year earlier, requiring we spend and extra 4% to buy the same things we bought 12 months ago and that any savings and investments must generate 4% (after any taxes) to keep pace with inflation. Since 2003, the Bank of England has used the consumer prices index (CPI) as its official measure of inflation (see also retail prices index).
Capital gains tax
If you buy an asset – shares, a second home, arts and antiques – and then sell it at a later date and make a profit, that profit could be subject to CGT. You don’t pay CGT on selling your main home (which is why MPs “flipped” theirs so regularly) or any securities sheltered in an ISA. Individuals get an annual CGT allowance (£10,600 in 2010/2011) but if you have substantial assets it’s worth paying an accountant to sort it for you.