ISAs aren’t just for grown-ups – tax-efficient saving is just as important for children.
The junior ISA was launched in November 2011 to offer parents a chance of building up a meaningful fund for their children who would benefit from a helping hand with university fees or buying their first home.
You can currently stash away £9,000 each tax year in a junior ISA – either in a cash or investment version of the account – where earnings are tax-free.
Laura Suter, head of personal finance at AJ Bell, said: “Often saving money for your children is on the life to-do list but can get forgotten about. Yet younger generations face a lifetime of financial challenges such as funding eye-watering university fees, saving a deposit for a property and less generous pensions schemes than older family members enjoyed.
“It’s easy to set up an investment account and start saving for your child, and if you automate the monthly payments you can make it as hassle-free as possible.”
Choosing your junior ISA
Most families keep money put aside in a cash junior ISA.
The latest published data from HM Revenue & Customs (HMRC) – for the tax year 2020/21 – shows that just over £1billion was subscribed to 943,000 junior ISAs that year, of which 71 per cent went into cash accounts.
With interest rates rising there are accounts paying around 4 per cent on offer.
On a £9,000 balance in an account paying 4 per cent you’ll bag £360 in tax-free interest in a year.
However, these rates don’t beat the current rate of inflation of 10.1 per cent, which means the value of savings is being eroded over time.
For a better bet at beating inflation over the longer term, parents should consider a stocks and shares junior ISA. Historically stocks and shares produce better returns than cash over the longer term.
According to calculations by AJ Bell, if you had invested the full junior ISA allowance each year from their launch – on 1 November, 2011 – and then subsequently at the start of the new tax year, contributions would total £62,836. If they had been invested in the FTSE All Share index you would now have £75,779 (up to 4 February, 2023).
If you saved the full annual allowance into a cash junior ISA earning 1 per cent interest a year over the same period, you’d have £66,298 – £9,481 less.
For those parents saving £100 a month into the FTSE All Share for the last 10 years, the value of the ISA would have grown to around £16,569.
In a cash version earning one per cent interest a year that would be worth just £12,680 – £3,889 less.
Suter adds: “Lots of parents keep money in cash for their children, but if you start saving when they are young investing could be ideal, as you have many years to ride out the ups and downs of the stock market.”
A long-term investment can also benefit from the superpower of compounding.
In simple terms, your money earns a return in the first year, and both the original cash and the return benefit from any growth in the second year. In the third year your investment is further enhanced by any returns achieved. This snowball effect is known as compounding.
It can turbocharge junior ISA returns over the long term.
Jason Hollands of wealth manager Evelyn highlights the benefit of paying a monthly amount into the junior Isa.
“Regular investing helps smooth out the effect of short-term market movements,” he says. “It is also a great discipline too to keep on going whether the economic news is cheerful or gloomy.”
‘I invest for all 5 of my grandchildren’
Retired chartered accountant Barbara Forrest, 69, invests for all five of her grandchildren in the hope they will have a decent nest egg when they turn 18.
Barbara, who lives in Surrey, believes that putting money aside in a cash account isn’t wise since over the longer term there’s a better option.
“There’s no point in using a cash savings account because generally stocks and shares do better.
“When I was saving for my own children we used savings bonds paying double-digit returns, so it wasn’t really necessary to invest. Today things are different, and I’d like the best return I can get on this money, which was left to me by my mother who I know would have wanted it to be somewhere sensible.”
Barbara asked the parents of her youngest three grandchildren – Ava, five, Heidi three, and Marnie, two – to open junior ISAs where she could invest a lump sum as well as additional amounts during the year for their future.
“I’m no funds expert so didn’t want to choose individual investments myself. I’ve chosen AJ Bell’s ready-made fund – the balanced fund. I know it’s been a difficult time for stock markets lately because I’m keeping an eye on my own pension. But I don’t check the junior ISA portfolios as the children are still tiny and I know they have plenty of time ahead to make up any losses.”
Barbara also invests for her two eldest grandchildren, Izzy, 15, and Oliver, 13, via child trust funds.
“I didn’t see much point in converting them to junior ISAs since they are not far from being able to take the money soon. The idea is to give them all a bit of financial independence when they turn 18 and use the money for something sensible. Izzy is considering a year travelling when she’s old enough, which would be a wonderful experience for her. This money would help her on her way.”
Investments for kids
When it comes to choosing investments to add to your junior ISA portfolio, you can choose individual stocks.
Instead of trying to pick the winners yourself, you can gain exposure to a group of companies by investing in a fund. Your money is pooled with that of other investors and invested in a group of companies.
Hollands suggests starting with a low-cost tracker style fund such as the Fidelity Index World fund, which has low 0.12 per cent annual costs.
It provides exposure to around 1,500 of the largest companies globally – though around two-thirds will be US giants such as Microsoft.
He adds: “It is worth considering combining this with a more modest amount into another fund which will provide exposure to fast-growth emerging-market countries such as India and China, such as the Fidelity Index Emerging Markets fund, which has a 0.2 per cent annual charge.”
Hollands also suggests the F&C Investment Trust, run by a manager who has selected more than 350 holdings, mainly in large, publicly listed companies in the developed world. It also includes modest exposure to emerging markets and private companies through investment in private equity funds.
If there’s only a small sum of money in the account, Suter suggests sticking to one fund that’s well diversified, rather than spending a lot on fees buying lots of different funds.
She tips Vanguard’s LifeStrategy range which has a differing amount in bonds and equity markets depending on the risk you want to take.
If you would prefer not to choose your own funds, most investment platforms offer ready-made portfolios.
They are usually a basket of five to eight funds which, when bought together, make up a well-balanced portfolio with the chance of good returns.
Platforms tend to offer a range with differing risk levels to choose from.
Starting a junior ISA is straightforward. If it’s a cash junior ISA you want, simply find the best rate using a price comparison website and in most cases you’ll be able to apply online.
Parents plumping for an investment junior ISA will need to open an online account with any fund supermarket such as AJ Bell, Bestinvest, Hargreaves Lansdown, Interactive Investor or Vanguard. You could also choose digital investment firms like Nutmeg or Wealthify which offer packages of funds rather than individual investments.
Once a junior ISA has been set up by a parent or legal guardian, anyone can contribute to it. The money is locked away until the child reaches 18 though children can start managing their account on their own from the age of 16.
Once your child turns 18, their junior ISA will automatically convert to an adult ISA.
Those aged 16 or 17 can have an adult cash ISA allowance of £20,000 a year as well as the £9,000 junior ISA limit.