How to make the most of Child Trust Funds

This week marks the fourth anniversary of the introduction of Child Trust Funds, a tax free, long term savings account introduced by the government to kick start saving for children.  The idea is that every child – not just the fortunate middle classes – will have a lump sum of money at age 18 which will give them the savings habit.

All children born since 1^st September 2002 are eligible for the £250 government CTF voucher and more than four million children now have a CTF, roughly 30% of all children.  Children from low income families and those in receipt of benefits receive a voucher for £500.  

CTFs vouchers are handed out when the parent registers for Child Benefit.  The Government will make a second contribution of £250 (£500 for low income families) when the child is seven and is considering a third in the child's teenage years.

The good news is that this government initiative to provide all children with a nest egg at age 18 and to encourage saving seems to be working. Children’s Mutual for example, one of the largest CTF providers, reports that around half of all its CTFs are seeing money being saved on a monthly basis.  Parents, grandparents and other friends and family can contribute up to £1,200 in any tax year to CTFs.

The average monthly direct debit being paid into a CTF account held with The Children’s Mutual is £24.  If this amount were paid monthly throughout the life of the fund, it could result in a lump sum of £9,750 after 18 years.  If an account similar to the CTF had existed 18 years ago and had been topped up with £100 per month, the current CTF maximum, it would be worth £37,800 today.

And with stock markets around the world some 40% lower than a year ago, now could be a good time to put that £1,200 into a CTF.  This time next year when the 2009-10 allowance expires share prices could be considerably higher. The £1,200 allowance, if not used, cannot be carried forward to a later year. 

Preparing for graduation

CTFs are a good way of saving for the high and increasing costs of university education.  Money invested in a CTF rolls up tax free and the child cannot touch the fund until it is 18.  Tuition fees are reviewed this year and the universities are calling for a big increase in the current £3,000 fees to £7,000. 

They are unlikely to get away with this but fees will inevitably rise.  Some estimates put the average student debt on graduation at £50,000 eighteen years from now.  This is not in the least bit fanciful given that some students graduate with debts of £20,000 today.

‘What is clear is that the cost of university is only going to increase, it’s just a case of by how much,’ commented David White, chief executive of The Children's Mutual. ‘There is a very real concern that parents could be jeopardising their own financial security to help their children avoid university debt by dipping into their own retirement provision – that’s why we’re urging families of small children to plan early and start saving now.’

Equity-based CTFs pay long-term

Parents can choose between a cash CTF or an equity based CTF.  The vast majority of CTFs are invested in cash but with an 18 year time horizon, an investment in equity based funds could prove a better bet and using the £1,200 top up facility is well worth while.  Assuming a return of 7% a year the fund would be worth £34,000 in 18 years time with a top up of £100 per month.