Child Trust Funds reach 18, but what are today’s investing for children options?

In September 2020, holders of the first Child Trust Fund accounts turn 18: will teenagers save it or spend it? We assess the performance of CTFs and suggest tips for investing for children.

It was 2005: Tony Christie’s Amarillo was the UK number one, the movie Downfall was released and David Tennant became the 10th Doctor Who. April 2005 also saw the official launch of child trust funds (CTFs) – less eye-catching or memorable, perhaps, but almost certainly with a more lasting impact for the recipients.

The earliest CTFs reach maturity this September, when the holders of the first accounts begin to turn 18. The product was replaced in 2011 by Junior Isas (Jisas), but, as our figures show, many of those 18-year olds getting access to their accounts for the first time will have good reason to be thankful for their CTF legacy.

• Invest with ii: Open a Junior ISA | Transfer a CTF to Junior ISA | Junior ISA Allowance

“The nudge effect meant many parents who otherwise would not have saved for their children did so,” says Craig Palfrey, certified financial planner at Penguin, a Cardiff-based wealth manager. “The voucher payment was a great way to get savings in place and many parents have continued to save on top.”

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Vouchers issued

More than 6.3 million vouchers had been issued by the time the government stopped sending them out in January 2011; 70% were taken up by parents, with the remainder invested by HMRC.

But there were significant drawbacks to CTFs as well, believes Tom Munro, owner of Falkirk-based Tom Munro Financial Solutions. “They were overly complex, with restricted investment amounts, an early maturity date and lack of investment choice,” he says.

Around 80% of CTFs were invested in stakeholder funds, the default option that was usually invested in UK tracker funds chosen by the provider. They were also designed to shift into lower-risk assets from the child’s 15th birthday, thereby reducing risk towards maturity.

The limited investment choice in stakeholder CTFs was exacerbated by the exclusion of investment trusts, while there was no access to higher-growth sectors (such as technology and smaller companies funds). The predominance of trackers also called into question a 1.5% charges cap that was far higher than typically levied on index funds.

How they fared

One of the criticisms of stakeholder CTFs was that performance fell a long way short of their potential, given the possibilities created by the long-term nature of investing for children.

The better performers included the F&C Investments (now BMO) Stakeholder CTF, invested in a FTSE All-Share tracker, and the Share Centre Stakeholder CTF (invested in the Legal & General UK Index fund), which would have grown 123% and 130% respectively. The data (see table below) are based purely on the initial £250 being invested as the default, with no monthly top-ups.  

The returns provided by mainstream funds and investment trusts in the 15-year period since CTFs were launched present a stark comparison. The average fund in the Investment Association’s (IA) global sector, for example, grew almost 240%, while the IA technology and telecoms sector returned 575%. Overall, the returns from stakeholder CTFs were more in line with the average funds in the IA’s various bonds and mixed investment sectors.

If you’d invested £250 in a mainstream non-CTF funds in April 2005 and topped it up by £100 a month over the 15 years, you would have enjoyed a potentially huge return on your regular investment. For instance, with annualised returns of 18.8%, the Candriam Equities Biotechnology fund would have turned your investment into more than £105,000 by the end of May 2020. SLI Greater China, Baillie Gifford Global Discovery, Wellington Global Healthcare and Axa Framlington Global Technology are among several other funds that would have made more than £75,000 from the same investment.

The returns produced by many investment trusts are similarly eye-catching, with an average return of more than £38,000 across all investment trusts for that period. The Allianz Technology, Biotech Growth, Polar Capital Technology and Scottish Mortgage trusts would all have made more than £100,000 from a £250 initial sum and 15 years of monthly £100 investments, according to the Association of Investment Companies (AIC).

Striking a balance

In reality, of course, no sensible investor would hold all their money in high-risk, high-return sectors, even if they were investing for the long term. So how do you go about investing for children?

In many ways it’s the length of time in the market that’s most important, thanks to the power of compounding – the snowball effect that occurs when the profits from investments, typically in the form of dividends, are reinvested and then go on to generate their own profits.

Investing for children isn’t always as linear as it might seem, however. While some parents might simply want their child to have a certain amount of financial freedom on reaching adulthood, others might be aiming for specific goals such as first-home deposits or further education funding.

“If the savings are needed for an event or particular time, then the risk position has to factor in the time horizon as much as anything else,” says Palfrey. “A child’s portfolio will probably have a more ‘risk-on’ approach as they have decades potentially ahead of them and a very long-term view is realistic, unless they need the money early in adulthood. So it all boils down to the goals of the parent for the money and the child.”

Effective saving for children is about tax planning combined with a cost-effective long-term buy-and-hold investment strategy, says Munro. “A good example of this is a well-diversified passive approach, such as the Vanguard LifeStrategy range, with an annual management fee of only 0.22% backed up by a strong track record.”

He adds: “This risk level will suit most investors’ needs, so long as they have the discipline to stay with the plan and the expected short-term market volatility is endured in order to profit from the predictable longer-term rewards.”

Volatility is, of course, a feature of markets in 2020, as the coronavirus pandemic continues to unfold. This is where diversification, the golden rule of long-term investing, proves its worth, according to Palfrey. “Your portfolio may be a little lower in value than six months ago, but if it’s well-diversified and left alone for 18 years or so, then the overall value will be far higher than what was put into it.”

Performance of a selection of stakeholder CTFs available since launch

Notes: Table shows cumulative returns and value of £250 invested from 6 April 2005 to 29 June 2020. Performance is not net of charges – unfortunately the charges data available is no longer CTF-specific. * Rebranded to BMO 2018. ** Later rebranded Santander Child Trust Fund. Source: Investment Life & Pensions Moneyfacts/Lipper, as at 29 June 2020.

How Child Trust Funds worked

Child trust funds (CTFs) were designed as a ‘nudge’ to get more parents and other family members saving for children by offering cash vouchers to get them started. The accounts were open to children born after 1 September 2002, with the first vouchers being issued from January 2005.

Parents were given vouchers worth £250 (or £500 for low-income families) to open their CTFs, with HMRC automatically opening accounts for eligible children if parents hadn’t done so. Parents (and grandparents) could pay in up to £1,200 a year, with income and gains building tax-free. There were three types of accounts – cash, shares-based and stakeholder (an equity-based account where charges were capped at 1.5% a year).

The money held in CTFs is locked in until the child turns 18, at which point it passes to them. Those gaining access to their accounts from September can either cash them in or transfer the money into an adult Isa.

Alternatives to Child Trust Funds

It’s nearly a decade since child trust funds were last available, but there are several other options still open to those saving for children.

Junior Isas (Jisas) are the most obvious. Like CTFs, these can be invested in cash, stocks and shares or both, and up to £9,000 can be paid in per child in the 2020/21 tax year. The money held in the account automatically rolls over into an adult Isa when the child turns 18.

Elsewhere, several investment companies offer children’s savings schemes, while children’s pensions offer a particularly tax-effective long-term option.

Trusts can be set up for children or grandchildren too. With bare trusts, for example, the parents have control of the fund until the beneficiary turns 18 and there’s no tax charge, although the child controls the investment entirely from age 18. Discretionary trusts are less formulaic and provide parents with more control after the child turns 18.

“Trusts are incredibly useful to protect invested sums or savings for the child, because they can restrict access to the money before it is needed or stop it being mis-spent,” says Craig Palfrey at Penguin.

When saving or investing for children it’s worth remembering that they also have an income tax personal allowance, which means annual income (including investment income) below £12,500 won’t be taxed. They also benefit from the personal savings allowance, so there is no tax to pay on the first £1,000 of interest generated by savings accounts.