Think back to when you turned 18 years old. What would you have done if, on that birthday, you were handed £40,000?
Would you have splurged it all on travelling the world during a gap year, or would you have been prudent and put it towards a housing deposit? You could have used it to start a business, or pay off your university tuition fees.
What’s certain is that it would have been a life-changing sum of money.
If you’ve recently had kids, or are planning to soon, you’re probably thinking about their future, and how you can give them the best chances in life. Imagine if you could give them that £40,000 when they come of age, and all the choices it would give them.
But how could you possibly save that much money? Actually, if you save regularly into a Junior Isa, it might be easier than you think.
These Isa accounts are very similar to the adult equivalent: both are free from income and capital gains tax, and come in two varieties – cash or stocks and shares. Provided you have a child under 18, you can open a Junior Isa on their behalf. But there are a couple of differences.
First, the annual limit is lower: parents can save up to £4,260 a year into a Junior Isa for each of their children, compared to £20,000 for standard adult Isas. Second, while a Junior Isa is opened and managed by a parent, the account is in their child’s name meaning the money belongs to them – control of the account switches to them when they turn 18.
Finally, savings placed into a Junior Isa can’t be accessed until the child reaches that age – so no, you won’t be able to tap into the Isa to buy your kid an early birthday present.
“I would argue that one of the best ways for a parent to save, invest, and provide for their children is to pay as much as they can afford to each year into a Junior Isa,” says Andrew Craig, founder of Plain English Finance.
“They are easy to set up and are a great way to save long-term without the temptation of dipping in and making withdrawals. You can make regular monthly payments via direct debit, deposit lump sums, or a mix of both – as long as you don’t exceed the annual £4,260 limit.”
Once parents have decided to open a Junior Isa, they then have to make an important choice: do they save the money in cash, or invest it into the stock market?
Currently, most parents prefer cash savings. In the last financial year, £514m was saved into Junior Cash Isas, compared to £388m into stocks and shares accounts.
Cash does have some advantages. It’s very low risk, and you know exactly how much your savings will grow, as the provider will pay a set amount of interest once a year. Meanwhile, the stock market is much higher risk as it is more volatile, meaning the value of your savings can go up and down.
Also, Junior Cash Isas tend to have better interest rates than the rest of the savings market: for instance, Coventry Building Society currently offers a Junior Cash Isa paying 3.6 per cent a year, whereas its top adult Isa only pays 2.3 per cent.
However, interest rates are still low across the board. Also, you have to consider the impact of inflation – the rising costs of goods. The UK’s inflation rate is currently around 2.1 per cent, which means that the “real” interest rate of the Coventry Building Society account is only about 1.5 per cent – which isn’t very impressive for your child’s savings. In fact, if inflation grows faster than interest rates, your savings are technically worth less than when you started, because the price of buying goods is higher than whatever you earned in interest.
So while cash offers the certainty of regular interest payments, the stock market offers much greater rewards – by investing in the shares of companies that trade around the world, the money you put aside for your child has the potential to grow much faster than cash.
For instance, if you had invested £100 a month into the stock market over the past 18 years using a basic UK tracker fund, you would have a savings pot worth £39,313, according to figures from investment platform Charles Stanley.
If you’d simply saved it in cash accounts paying standard interest rates, you would have accumulated just £24,000 – a difference of almost £16,000.
“Over longer periods, cash is unlikely to grow fast enough to keep up with inflation – the increase in the cost of living – let alone outpace it,” warns Rob Morgan, pensions and investments analyst at Charles Stanley.
“As investments for children generally have time on their side, taking on the risk and volatility of the stock market in pursuit of higher returns is often worth considering.”
Understandably, parents may be worried about investing in shares, and may fear losing their child’s investment to a stock market crash or a business going bust. However, by being able to put money aside for your child for up to 18 years, this long-term investment horizon will mean that you can ride out any dips or falls that the market may experience.
“Parents considering a Junior Stocks and Shares Isa may feel as if they’re gambling with their child’s money as there is always a risk element to saving in stocks,” says Craig.
“It’s true that stock markets crash, however, crashes come and go, and historically, markets spend more time trending up than down.”
There is a simple way for parents to mitigate the risks from a stock market crash – diversifying. This means that rather than buying shares in a single company or in only one market, they build a diverse portfolio of funds for their child. Doing so will mean their money is invested in hundreds of companies around the world – if one business or country does badly, it will be balanced out by others that are doing well.
“The great thing about a Junior Stocks and Shares Isa is that you have the option of investing in markets all across the globe. I call this ‘owning the world’, and it is an approach with a multi-century track record used by many of the wealthiest people in the world,” explains Craig.
If you want to give your child a brighter future, consider saving money for them in a Junior Isa. The earlier you start, the longer this nest egg will have to grow and the larger it can become. Then when they turn 18, they can afford to buy you the first round at the pub.