This piece first appeared in Reader's Digest in December 2000
 The text here may not be identical to the published text

Cash gifts for Christmas

Christmas is coming and the search is on for a goose that will not only get fat but will lay that golden egg for your children, grandchildren, or younger relatives. Money may not be the most exciting present to receive, but it can be pretty exciting to have – especially in years to come when your little one has grown up and wants a car, a flat, or a university education. So as well as the inevitable computer, bike, or mobile phone, give some thought this Christmas to giving cash.

Investing for a child is much the same as investing for yourself. You should make sure there is a mixture of cash and longer-term investments. Cash, which the child knows about and perhaps manages, is important so they can learn the value of savings and the magic of them growing through interest. The longer-term investments are there to build up for those times when they are needed in the future. So you can plan a long-term investment aiming for a 16^th or 18^th birthday. Remember that long-term is never less than three years – five or ten is better.

The government gives every mother or father a £15 a week cash payment (Child Benefit) for the first child and £10 for each other child. If you do not need that money it is a very good amount to invest for your child’s future. From April next year there will also be a Children’s Tax Credit, worth £8.50 a week for most parents. Add that to the pot and you have got more than £1000 a year for one child, rather less each if you have two or more. But if you save even half of that from when a child is young, they will have a very nice sum to start them off in life when they reach 18 or 21.

CASH
Some cash is at the heart of any savings plan. You can take money out and put it in as you want – or need in an emergency. For people under 18 there are lots of special children’s accounts that pay good rates of interest. Be careful which one you choose. The best is currently Nationwide which offers 6.95% on any amount on an instant access account. The child gets a welcome pack and a magazine. The very worst on offer is 1.2% from First Trust Bank. I doubt if the free teddy bear, height chart, and birthday card are worth the difference!

To open an account you can start it in the child’s name. Normally that means they will have some access to it from the age of 7. Alternatively you can open it in trust for your child. That makes it clear it is not your money, but it is not theirs either. At 18 it becomes theirs, though as one independent financial adviser said to me "If they don’t know it’s there, they can’t get it even when they are 18 can they?"

TAX
To you they may be your beloved children. But to the Inland Revenue they are tax units. Normally there will be no tax to pay on the interest earned on a child’s account. Everyone – from the youngest babe to the oldest citizen – is allowed some tax-free income each year. For people aged 0-64 this tax year that is £4385, or around £365 a month, before any income tax is due. Such an income would normally be beyond the dreams of most children. It implies nearly £70,000 in a savings account (at 6.5% p.a.) to generate that sort of money. But the Revenue is very well aware that canny parents might put money in the name of the child but then use it for their own purposes – perhaps just keeping the child. So if a parent gives money to a child of their own and it generates at least £100 a year interest, then all the income from it is taxed as the parent’s. That means that if your child has more than £1540 in a building society account (at 6.5% that is £100.10 a year interest) and that money came from you, then you will have to pay tax on all the income, not just the surplus above £100.

There are three ways to keep the income below that limit. First, the £100 applies to income of each child from each parent’s gift. So you could give £1500 and your husband or wife could give another £1500. It is probably best to put the money in separate accounts and call them by an appropriate name ‘mum’s account for AB’ and ‘dad’s account for AB’. Second, money from relatives is not subject to this rule. So a grandparent, uncle or aunt, godparent or any other relative or friend can give money without tax implications. But make sure the cheque is written out directly to the account to avoid arguments with the taxman.

Remember that 20% tax is normally deducted automatically off all interest on a bank or building society account. To avoid the hassle of claiming it back each year, get form R85 from you bank or building society to register for the interest to be paid gross.

LONG-TERM
Once the cash is sorted out you will want to think of something longer term to take advantage of the capital growth you get out of the stock market. If you start early and plan for the money to build up over 18 or 21 years, then you really can give your child a very nice present when they reach adulthood.

My advice is always the same for those beginning to dip their toe into the stock market – go for a tracker fund, that is one which tracks the average of around 900 companies that form the whole London stock market (or the biggest 100 companies if you prefer). In the long-term those funds will do better than most funds and very much better than interest on cash. They do not all perform the same so go for a well-known name, with low charges – they should take no upfront charge and no more than 0.5% a year of your investment to run it. You can invest a lump-sum or put a monthly amount in, though most funds insist on at least £500 or £50 a month. One exception is the Rupert Fund run by Invesco which allows lumpsums as low as £50 or a £20 a month regular investment. However, it has to be said it is not a brilliant performer, well outside the top 100 unit trusts.

An alternative which locks the money up for a fixed period is a with-profits endowment. They go up and down less than direct stock market investments. Once started, the money is effectively locked away until what is called the maturity date (of the money not your child!). So you could start one to mature when they reach 18, another at 21. Although endowments have received a bad press, they can be good long-term investments. But they must be kept to the end or the return is poor. To pick the right one you need to see an independent financial adviser.

People under 18 cannot invest directly in the stock market. So you take the investment out in your name on behalf of the child – that essentially sets up a trust. Make sure it is a fund that grows in capital value, and does not produce income. In that way there is no danger that the £100 a year tax limit is exceeded.

Finally there is the National Savings Children’s Bonus Bond. The rate of interest is not good but it is backed by the Government – 5.25% if they are held for five years. If you cash them in early, the interest rate is derisory. You can buy the bond for anyone under 16. There is a minimum of £25 and a maximum of £1000 per child. At the end of the five years £1000 will become £1291.55. There is no tax for you or the child to pay on this interest.

December 2000

e-mail Paul Lewis on paul@paullewis.co.uk