Child trust funds versus Junior Isas

CTFs

CTFs were a long-term tax-free savings account for children automatically opened for every child born between September 2002 and January 2011. The scheme was introduced by the Labour government in 2005.

Each new account created for a child born after September 2002 was credited with a starting fund of £250, though this was reduced to £50 in May 2010 when it was announced the scheme would be phased out the following year. Children of low income families could receive double the contribution from the government.

All payments into child trust funds were stopped in January 2011. Money can still be paid into existing accounts.

The money was provided in the form of a voucher to the person claiming child benefit which could be used to open an account, with HMRC setting up an account automatically if the voucher was not used. A second voucher was to be issued at age 7.

Parents of children eligible to receive a child trust fund can From July of this year add up to £4,000 each tax year to the account. There is no tax to pay on the amount held in any type of child trust fund and it will not affect any benefits or tax credits received by the parent.

There are three main types of child trust fund account:

1) Stakeholder accounts have to follow government rules, including investing the money in a number of companies not just one, and the money must be moved to lower-risk investments when the child is 13.

2) Share accounts invest your child’s money by buying shares in companies. The value can go up or down.

3) Savings accounts work in the same way as a bank or building society account. Money invested is secure and earns interest.

Although the money in the account belongs to the child, they will not be able to withdraw funds until they have reached 18.

Jisas

Launched in November 2011, the Junior Isa is a tax-efficient savings account designed for those aged less than 18-years-old. It was created following the government’s decision to scrap the child trust fund for children born after 3 January 2011.

Unlike the CTF, the Junior Isa is not opened automatically for a new child and does not receive a free contribution from the government. As a result, it is down to the parent to open the account on behalf of a child.

A Junior Isa works in a similar way to an adult Isa and parents can invest up to £4,000 each tax year until the child’s eighteenth birthday.

According to HM Revenue & Customs, there are two types of Junior Isa:

1) A cash Junior Isa, i.e. you will not pay tax on interest on the cash you save.

2) A stocks and shares Junior Isa, i.e. your cash is invested and you won’t pay tax on any capital growth or dividends you receive.

Your child can have one or both types of Junior Isa.

Comparing the two

One significant advantage of a Junior Isa, according to Andrew Gillespie, sales and marketing director of Family Investments, is that, once set up by the parent or guardian, anyone can contribute to a child’s Junior Isa, including grandparents, godparents and family friends alike.

An additional benefit is that, similar to a child trust fund, Mr Gillespie points out a Junior Isa is tax efficient, which means the returns aren’t subject to normal tax treatment.

Mr Gillespie says: “It is important to remember that the money in a Junior Isa is locked away until the child reaches 18 and only then will the child alone have access to it. As such, Junior Isas aren’t suitable for parents who might need emergency access to their child’s savings.

“Family Investments finds that many parents like the discipline this lock-in provides, and grandparents especially like the fact that their monetary gifts are earmarked for the child’s future.

“It is also worth noting that, unlike regular Isas, a child can only have one Junior Cash Isa and one Junior Investment Isa at any one time – and only up to the combined annual limit of £4,000.”

The key advantage of a child trust fund was the initial government subscription, which then grew in the account tax free.

However, Rob Morgan, pensions and investments analyst at Charles Stanley Direct, says many CTF products have higher charges, lower interest rates and less investment choice than their Junior Isa counterparts.

He says: “The investment flexibility of Junior Isas is excellent and, just like adult Isas, they can be invested in cash, funds, shares, investment trusts, exchange traded funds and more. They can also be low cost. As there a large number of providers there is a competitive market for the product.

“If the money is not taken at 18 a Junior Isa can be turned into an adult Isa, continuing the investment indefinitely – a distinct advantage over CTFs.”