What next for children's investments?

Soon after the election and subsequent hung parliament result in May, the government announced that its contributions to Child Trust Funds (CTFs) would be ending. More recently, the forthcoming increase in university tuition fees was announced, in a move that is likely to increase the financial strain on students.

Even before these recent developments, the Association of Investment Companies (AIC) own research found that the average student starting university in 2010 is likely to graduate with more than £24,000 of debt. In the face of increasing financial burdens in many aspects of life, it is more important than ever that those with the means to invest on behalf of a child take a long-term view and plan early.

The government's news that it plans to introduce Junior ISAs is an initiative that we welcome, even though there won't be a contribution to kick-start it. The future financial security of children is a key focus for the AIC and the Junior ISA has the potential to be a simpler and thus more attractive savings option for parents than the CTF.

If we remove CTFs from the current scenario, parents and grandparents wanting to invest for children often choose a children’s bank or building society account. This is disappointing since interest rates are so derisory and, over the long term, they are not likely to do much more than keep up with inflation.

An investment-based approach has much greater potential to deliver a decent lump sum that is able to ease the pressure of university costs. Of course, we know that stock market investments carry a much higher level of risk but a long term investment allows time to ride out the market ups and downs.

Moreover, historical performance figures emphasise just how wise this approach can be: a £50 a month investment* into the average investment company over the last 18 years would today be worth £22,720.

As and when mum and dad have decided on the merits of an investment-based approach for their kids (for example an investment company savings scheme) they should find that Junior ISAs will have merits compared to the current saving for children options which can be surprisingly complicated. Currently, parents have to decide between a designated account route and setting up a Bare Trust.

This can be a tricky decision and one that may require financial advice, since there are tax implications. The first option is flexible since you set up an account with the child’s initials and can choose when to hand over the proceeds to the child. This requires discipline since you can change your mind and decide to keep the proceeds!

The investment remains yours for tax purposes. At the other end of the scale, a Bare Trust option is much more formal since the child becomes the beneficial owner and, once set up, it cannot be revoked. Not all management groups offer a Bare Trust option, so for a formal trust arrangement like this it may be necessary to consult a solicitor.

At the very least, the Junior ISA will remove complexity. If it works just like an 'Adult ISA' we imagine that it will be very popular and become the first port of call for long term children's investments.

What we won't know for a while yet is the annual investment limit, even though there's already lots of speculation. Let's hope that it's enough to really give children a significant and tax-efficient kick start.

Ian Overgage is acting communications director of the Association of Investment Companies (AIC). The views expressed here are his own.

*Performance figures are to 31 October 2010, mid-market share price total return with net income reinvested and a 3.5% deduction for charges, stamp duty and market spread. Source: AIC