What is the best way to save for your children?
A good friend of mine recently posed the following question:
“We want to open a bank account for our new baby – I’ve read a bit online, but I can’t see the wood for the trees! Any advice?”
This is a very interesting question and one that is probably at least a consideration for all new parents. Luckily, investing for your baby’s future is very similar to investing for your own. Therefore, I imagine that most of the methodology will be familiar to you.
“Invest” in your children, do not “save” for them.
A couple of slight modifications to the title and one word in the question.
If you are looking to put money away for a period of more than 8-10 years, then “saving” will be much inferior to investing in the stock market.
You may be worried about losing all your money and your children suffering due to stock market risk. However, over that time frame, it really isn’t a concern. Take the FTSE All Share as an example.
- The average 20 year period since records began in 1973 provided approximately 12% per annum returns
- The worst 20 year period, including the 2000 dotcom bubble and the 2008 financial crisis still returned over 6% per annum.
The current best rate for junior ISAs (see below) is 3.25%.
To understand the impact of this, let’s look at an example. Imagine you can save £1000 a year towards your child’s investments, which shall be invested on the day they are born and not touched until they are 18.
- Under the cash alternative (3.25% per annum), the total £18,000 invested would be worth £23,950.
- Under the FTSE All Share alternative (12% per annum), the total £18,000 invested would be worth £55,750.
So, hopefully this has convinced you that investing beats saving for your children. If you need more convincing, see the What Should I Invest In article on the moneystepper site.
Which brings us to the second small amendment. If you are looking towards the long term for your new baby, a bank account will not be the appropriate vehicle.
However, what will? There are many options involved, but I personally believe that only two are required for consideration if you are investing for the long term for your children.
Option 1: Junior ISA
A Junior ISA is very much like a regular ISA for adults. You place money into the ISA up to a predefined limit each year, which can either be kept in cash or invested in the markets, and any income or capital gains within the account shall remain completely tax free.
The defining elements of a JISA are:
- Limited to £4,000 to be entered into the JISA each year (limits will inevitably increase with inflation).
- No withdrawals are allowed until the child’s 18th birthday (unless your child dies or becomes terminally ill).
- Upon reaching 18, only the child and no one else, can release the funds.
- Any amount in the ISA can be rolled into their own adult ISA when the child turns 18.
Key Benefit: the investments are tax free during both the years before your child turns, and after he becomes an adult. Given the alternative below, and assuming that you can teach your child to be good with money (it is irrelevant if you uses it all to buy a sports car on the day he turns 18), this is a major advantage.
Major Disadvantage: whilst the money is “managed” by the parents, absolutely no withdrawals can be made until the child is 18. Therefore, you should only invest money in these accounts that you are 100% sure that you won’t need access to.
Option 2: Use your own ISA
The current annual limit for adult ISAs is £15000 per year. Therefore, if you are not using all this amount, you may wish to put aside a pre-defined amount for your baby each year and then assume that your average return is applied to this cash to work out how much will be theirs when they become an adult.
Major benefits compared to the Junior ISA are:
- You can decide when to give the money to your child (be it before they turn 18 or after) depending on when you think they need or will make the best use of the funds.
- If you REALLY need to access the money in the shorter-term, you can make withdrawals freely from an adult ISA.
However, the disadvantages are:
- If you transfer the money to your child and they don’t immediately use the money, they may not be able to wrap it all in ISAs or tax wrapped investment vehicles and hence it may be slightly less tax efficient
- This is only an option is you are not using your £15000 limit yourself.
What would I personally do?
This might sound like I don’t have faith in your future children, but I don’t like the idea of your 18 year old child suddenly coming into a significant sum of money just before they head to university. Instead, I would rather control the cash and provide it at the times that they need to spend it. I know that when I was 18, I would not have made the best use of thousands of pounds granted to me!
Therefore, if you are not already using your £15000 ISA allowance, I would opt for option 2. Then, any time my future child was about to take on debt (tuition fees, new house, wedding, etc) I would release some of their money as I deemed fit. After all, it is your money. You don’t want to work hard for it for 18 years to see your child frivolously waste it!
By only releasing the funds to your child in order for them to spend it on specific items, the tax benefits of the ISA are never lost.
So, I’m investing? What should I invest in?
Great, so I’ve decided that I’m going to use some of my ISA allowance for my child. But, what should I invest in?
Well, keep it simple. You don’t want to be a fund manager for your child! Just invest in low-fee, passive ETFs which track major established markets and reinvest all dividends.
For more detail on how, and why, you should do this, see almost all articles in our “investing” section!
I hope that helps and that your newly born baby will be grateful in 20 years’ time!! 😉