Benefit from the new Junior ISAs with investment trusts
The child trust fund (CTF) is no more. Long live the Junior ISA. The face of mainstream children's savings has changed once again just as investing for children has become an increasingly sensitive issue, with the costs of educating, clothing and entertaining the smallest members of the household rising.
The investment trust market is participating fully with many of the large providers planning to launch Junior ISA wrappers for their trusts over the next few months.
The structure of the Junior ISA has been largely applauded by the industry, pleased that the popular ISA format will now be available to those under 18. In many ways Junior ISAs resemble their senior equivalent: investors have the choice of a cash or stocks and shares account and each child can hold one of each account at any time.
Income or capital gains made on the account will be tax-free. It differs in that the annual limit is lower, at £3,600, and no capital withdrawals can be made until the child is 18. If no money is taken out at 18, the account will roll over into a standard ISA.
Any income is tax-free and does not get caught by the £100 income limit on children's savings, but that income belongs to the child and therefore cannot necessarily be used for school or university fees, unless you happen to be persuasive or have a child with a rare eye on their future prospects.
It is a useful way to build a nest egg, such as for a deposit on a house, within a tax-sheltered environment, but parents need to be aware that - as with the majority of children's savings products – the child is entitled to spend it as they please at age 18.
The new ISAs may not receive any government contributions, but they have some advantages over the child trust funds that they replace. They do not have the "stakeholder' requirement of CTFs.
In theory this was designed to keep costs low for investors but in practice, it meant that the choice of providers was relatively small. Without this requirement many more investment management companies are likely to enter the market, giving parents a much wider choice of providers and funds when selecting a Junior ISA.
It should be said that children with an existing CTF are not entitled to open a Junior ISA and CTFs will remain open for additional investment.
Those signed up
A number of investment trust managers have already thrown their hats in the ring. The giant investment trust Witan, already a well-established player in the children's saving market, has led the charge and will be launching its Junior ISA in November. James Frost, marketing director for the trust, says he has already seen a lot of interest in the area.
He adds: "A good few hundred people have pre-registered. These are often parents of those children who don't qualify for child trust funds, but whose siblings did. We have 18,000 Jump accounts now and more holders [aged] under five in the trust than over 70. There is a real demand for children's savings now."
James Saunders Watson, head of investment trusts at JP Morgan, says Junior ISAs are likely to become an important part of anyone's savings plan for children and the group plans to launch their own Junior ISA in due course.
F&C also plans to launch a Junior ISA, though it is unlikely to be before the 1 November deadline this year. Fund supermarkets such as Fidelity FundsNetwork have also announced plans to open Junior ISA accounts, through which parents will have access to a wide choice of funds (including investment trusts), shares and other investments.
As the Junior ISA off ers a wider choice, parents will have to examine their options more carefully, including the case for investment trusts. At the heart of the case for saving for children through investment trusts is that any children's savings plan has a lengthy time horizon. This lends itself to investing in less liquid, higher growth areas, such as emerging markets or smaller companies, which are the natural stomping ground of closed-ended funds.
Saunders Watson says: "If your time horizon is long, your appetite for risk should be greater. If you have a toddler, you have around 16 years to invest. Those markets with the strongest GDP growth are likely to give you the strongest protection against infl ation over that time."
The Association of Investment Companies' website can steer investors to trusts focused on capital growth (www.theaic.co.uk/Search-for-an-investmentcompany/Step-by-step-search/Con...). It allows investors to compared long-term performance for growth trusts in different regions.
This longer time horizon also means that the benefits of lower costs – generally a feature of investment trusts – are more apparent. Even if an investor seeks income rather than growth, the investment trust structure has its advantages.
Investment trusts can reserve part of their income, while open-ended funds have to pay it out every year. This can create a steadier income flow. Such has been the popularity of many of the income trusts that many now trade on a premium.
However, the recent market rout has brought some down to more reasonable levels. Investors looking for income-generating investment trusts can follow the steps on the AIC website to build a shortlist (www.theaic.co.uk/Search-for-an-investment-company/Step-by-step-search/Co...).
Minimum investment levels are generally lower for investment trusts over unit trusts and Oeics. Jason Hollands, head of corporate aff airs at F&C, says: "When it comes specifically to the issue of using investment trusts for children's savings, many parents and grandparents tend to invest on a regular savings basis or by making ad hoc small investments, often at subscription levels below the minimum levels required by most openended fund providers (£1,000 lump sum per fund)."
He adds that global generalist trusts are particularly appealing in these circumstances since they provide a "one-stop shop' for the small saver who will not be in a position to buy a sufficiently diverse portfolio of open-ended funds or specialist and single-market investment trusts. The larger global growth trusts will incorporate a spread of investments.
For example, the Foreign & Colonial and Witan investment trusts both include exposure to private equity funds and alternative investments as well as internationally listed equities across both developed and emerging markets. It would be difficult to replicate a similar
portfolio without incurring additional costs. The total expense ratios for both funds remain low – at around 0.5 per cent – compared to both their peer group and their open-ended fund equivalents. Some of these trusts will also have a dividend payment. Foreign & Colonial Investment Trust, for example, pays a current yield of 2.4 per cent.
Of course, it doesn't have to be one or the other. Fund supermarkets can offer a means to build a portfolio of investment trusts and to change the selection each year. In this way, parents can build a blended portfolio of income and growth opportunities.
Costs can mount up if there are individual transaction charges for each share bought. Parents could end up paying, for example, £12.50 per purchase for five investment trusts, and therefore need to be sure that they can add sufficient value over and above, say, a global generalist trust to compensate for the higher upfront charge. The cost difference will depend on the platform charges and will be the same as buying an individual share.
Danny Cox, head of financial planning at Hargreaves Lansdown, prefers the larger generalist funds for his clients. He says: "For children's savings I like long standing trusts such as Witan, F&C Capital and Income, and the Edinburgh Investment Trust run by Neil Woodford.
We would look to some of the Aberdeen emerging market trusts for higher-risk investments.'
Junior ISAs are an easy first port of call for parents looking to save for children, but there are other options. Cox highlights bare trusts as a possible option for parents who may want their children to have access to the cash before 18 or have hit their ISA limits. He says: "Individual shares, investment trusts and unit trusts cannot normally be bought directly by a child and are usually held in a designated account using a bare trust.
"Commonly, money can be passed as a gift into the trust and held or invested until such time as the trustees distribute money or assets to the beneficiaries. Trusts can allow investors – or someone they nominate – to retain control over when and how monies are distributed. As such, they are useful for saving for children, because they allow investors to pass on money before children are old enough to be given the money directly.'
Bare trusts are the simplest type of trusts and the child becomes automatically entitled to the investments at 18, but the trustee can distribute money earlier for the child's benefit if they need to, perhaps to meet school fees. For tax purposes the account belongs to the child and is simply administered by the trustee.
Cox adds: "In the majority of cases any tax liabilities fall on the child but in practice there is usually none to pay.' Andrew Swallow of Swallow Financial Planning, says that this is his most frequently- used children's saving option: "We do quite a few bare trusts from parents for their children to be used for university or first home purchase. We tend to use passive funds to build the underlying portfolios, but investment trusts remain an excellent managed alternative.'
Pensions are also an option. It may seem like jumping the gun – or even a little cruel – to contribute to an account for a two-year-old that they can't access until they are 55, but not only are there genuine tax advantages to doing so, it means your children may not have the tiresome game of catch-up that their peer group will be playing with their pensions. It puts more disposable income in their pockets that would otherwise have had to be spent on pensions contributions.
Mike Morrison, head of pensions development at Axa Winterthur, says that parents have the advantage of knowing the cash is not going to be touched for a period of time, which allows for some investment flexibility.
He adds: "You can set a pension up as soon as a child is born. It is extremely tax-efficient for grandparents, or whoever makes the contribution."
Tax relief is given according to the earnings of the pension member, not the person paying into it. If someone opens a pension for a child, they only have to pay in £2,880 a year and the government tops up the rest in tax relief to the maximum of £3,600 (assuming the child is non-earning).
There is only more tax relief if the child is a higher-rate taxpayer. Cox estimates that a child whose family had contributed the full £2,880 each year for 18 years, could have a pension pot worth over £1.8 million by the time they reached 65 (assuming 6 per cent annual growth), even if the child saved nothing more in adulthood. By contrast, someone who saved £2,880 a year from age 19 to 65 could retire with just over half that amount – £920,000.
He adds: "One of the great advantages of starting to save for retirement early is maximising the benefits of compound growth. Investors are often wary of handing large investments over to children on their 18th birthday. Invest in a pension and they can be certain their money is ring-fenced for their retirement.'
That said, Swallow believes there are drawbacks. He says: "Our view is that investing in pensions, while very taxefficient, isn't going to be as helpful to one's offspring or grandchildren when they are young. Certainly, if you find your adult children wayward then buy them pensions but give the youngsters some flexibility. With university costs and property costs rocketing they will need all the help they can get when they reach adulthood.'
Of course, some parents will find the idea of their children having access to a pot of cash at the footloose age of 18 unpalatable. If this is the case, they will have to rely on the own pension and ISA savings to support their children, which may not be as tax-efficient. In all this, financial education is a useful weapon. With a bit of forward planning, they might even support you in your old age.
This article was written for our sister website Money Observer
Available from 1 November 2011, the Junior ISA will replace child trust funds (CFTs), which have been phased out. Junior ISAs will have a £3,000 limit and will be offered by high street banks, building societies and other providers that currently offer ISAs to adults. You can invest in either stocks and shares or cash. But, unlike CTFs, there will be no government contributions into each child’s savings pot. Money invested in Junior ISAs will be “locked in” until the child is 18, and the ISA will default to an adult one.
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).
The general term for the rate of income from an investment expressed as an annual percentage and based on its current market value. For example, if a corporate bond or gilt originally sold at £100 par value with a coupon of 10% is bought for £100 then the coupon and the yield are the same at 10%, or £10. But if an investor buys the bond for £125, its coupon is still 10% (or £10) and the investor receives £10 but as the investor bought the bond for £125 (not £100) the yield on the investment is 8%.
Investment trusts are companies that invest money in other companies and whose shares are listed on the London Stock Exchange. As with unit trusts, private investors buying shares in an investment trust are buying into a diversified portfolio of assets (to reduce risk), which is managed by a professional fund manager. Investment trusts differ from unit trusts in two important ways: they are listed on the stockmarket and so are owned by their shareholders and are closed-ended funds with a finite number of shares in issue. This means the share price of investment trusts might not reflect the true value of the assets in the company (known as the net asset value, or NAV) and if the NAV value of a share is £1 and the share price in the market is 90p, the trust is said to be running a discount of 10% to NAV. But this means the investor is paying 90p to gain exposure to £1 of assets. Investment trusts can also borrow money and use this money to buy investments. This is known as gearing and a geared trust is thought to be more of an investment risk than an ungeared one.
Invidivual Savings Accounts were introduced on 6 April 1999 to replace personal equity plans (PEPs) and tax-exempt special savings accounts (TESSAs) with one plan that covered both stockmarket and savings products, the returns from which are tax-exempt. The ISA is not in itself an investment product. Rather, it’s a tax-free “wrapper” in which you place investments and savings up to a specified annual allowance where the returns (capital growth, dividends, interest) are tax-exempt (you don’t have to declare ISAs and their contents on your tax return). However, any dividends are taxed within the investment, and that can’t be reclaimed.
Generic, loosely-defined term for markets in a newly industrialised or Third World country that is in the process of moving from a closed economy to an open market economy while building accountability within the system. The World Bank recognises 28 countries as emerging markets, including Argentina, Brazil, China, Czech Republic, Egypt, India, Israel, Morocco, Russia and Venezuela. Because these countries carry additional political, economic and currency risks, investors in emerging markets should accept volatile returns. There is potential to make large profit at the risk of large losses.
An interchangeable term for shares (UK) or stocks (US). Holders of equity shares in a company are entitled to the earnings and assets of a company after all the prior charges and demands on the company’s capital (chiefly its debts and liabilities) have been settled. To have equity in any asset is to own a piece of it, so holders of shares in a company effectively own a piece proportionate to the number of shares they hold. (See also Shares).
The total money value of all the finished goods and services produced in an economy in one year. It includes all consumer and government consumption, government spending and borrowing, investments and exports (minus imports) and is taken as a guide to a nation’s economic health and financial well being. However, some economists feel GDP is inaccurate because it fails to measure the changes in a nation's standard of living, unpaid labour, savings and inflationary price changes (such as housing booms and stockmarket increases).
If you own shares in a company, you’re entitled to a slice of the profits and these are paid as dividends on top of any capital growth in the shares’ value. The amount of the dividend is down to the board of directors (who can decide not to pay a dividend and reinvest any profits in the company) and they will be paid twice yearly (announced at the AGM and six months later as an interim). Dividends are always declared as a sum of money rather than a percentage of the share’s price. Although dividends automatically receive a 10% tax credit from HM Revenue & Customs (HMRC), which takes the company having already paid corporation tax on its profits into account. Dividends are classed as income and, as such, are liable for personal taxation and so shareholders have to declare them to HMRC.