Child trust funds: Features explained
Ethical investment products have extended to include CTFs as well
Child trust funds (CTFs) were introduced in April 2005 to encourage long-term saving and give all children a financial asset when they reach 18.
Under the scheme, all eligible children will receive at least £250 from the government to invest in a special CTF account. Friends and family are then able to top up the account while the child is growing up, but the money will be locked away until the child turns 18.
Fund options
There are three main types of CTF account to choose from, offered by a range of providers including banks, building societies and friendly societies. Within these three categories are numerous financial products including straightforward cash-based savings accounts or share-based accounts for those who fancy a flutter on the stock market.
Cash CTFs
A cash CTF acts just like a savings account, except the interest is tax-free.
This is the safest and simplest option, especially if you're uncomfortable with the idea of investing your child's money in the stock market. But the money may not grow as much as if it was invested in shares.
If you choose this option, check rates regularly and switch if necessary.
Stakeholder CTFs
Stakeholder accounts are riskier than straight-foward cash accounts, but the cost is lower and risk less pronounced than with share-based accounts.
Although stakeholder CTFs do invest in shares, they have to meet certain conditions regarding the type of investments allowed and must hold a spread of investments across different markets, sectors and securities.
Investment based accounts are riskier but could generate healthy returns
Also, when your child turns 13 the fund is 'lifestyled' which means it's gradually transferred to less risky investments such as government bonds.
Most stakeholder CTFs charge the maximum annual management charge they are allowed to do which is 1.5% (which is some cases is more expensive than share-based accounts).
This means that stakeholder CTFs must grow by 7.5% a year, just to match the best cash CTFs, which given their investment strategy will be hard to do - especially after the fund is 'lifestyled'.
Stakeholder CTFs do offer a convenient way to invest in stocks and shares, but their low-risk investment strategy combined with their high charge means the funds will have to work consistently very hard indeed to beat the best cash rates currently available.
If you want to invest your CTF into stocks and shares, you might find lower charges and a higher potential growth with non-stakeholder share-based accounts.
Share-based CTFs
Share-based accounts are worth considering only if you're willing to take a risk with your child's fund.
There are two types of share-based account. The first offers you access to a limited range of investment funds. You put your money into one or several of the funds on offer, switching between them whenever you like (although you may be charged for this).
The second type works on a 'self-select' basis, which essentially means you can choose from almost any fund you like from a huge range of providers and buy shares directly too, all within the CTF wrapper. The charges for these accounts vary enormously depending on what you go for and how frequently you move money around.
Historically, investing in shares has usually provided a better return over the long term than savings accounts, however, it's a riskier option as the share value could go down. It’s also more costly than investing in cash as charges have to be made to the account for management.
Remember that any growth your share-based CTF makes will have to cover the charges imposed before you start to make a profit.
Tip: If you are unsure of the product that is right for you then it is best to seek professional advice, putting the voucher in a Best Buy cash account in the meantime to ensure it's earning a good rate of interest.
Shop around for a good deal to make the money work a lot harder for you
How much you will get
The £250 voucher will be sent directly to you when you claim child benefit. Children in families with lower incomes (earning less than £13,910 in 2005/06 and receiving child tax credit) will have an additional £250 paid directly into their account.
The government will also make another payment into the account on your child's seventh birthday. The government is consulting on whether this should be another £250 or £500 (depending on income).
Topping up the account
Once you've opened the account with your £250 voucher, you can add your own money and friends and family can contribute too. The maximum you can pay in is £1,200 a year.
Government contributions and interest don't count towards this limit, however. The start date for each year is your child's birthday, except in the first year, when it will start from the date the account is opened.
Taking money out
Only your child will be able to access the money and, once you've made a contribution, you can't take it out. But your child won't be able to withdraw the money until they are 18. At this point, they can choose what they want to do with the money – spend it or invest it further.
Tip: If you choose a CTF savings account keep an eye on the interest rate and switch if necessary so you've always got the best deal. You can even switch from a savings account to a share-based one or vice versa.
If you want a share-based account, look carefully at the charges. Most stakeholder CTFs have an annual fee of 1.5%, which will eat into your investment.
Anyone can pay into the account, so encourage friends and family to contribute and it could be worth a decent sum in 18 years' time.