Investing a lump sum for a child: What are the options?

Your children (or grandchildren) may not have incomes of their own, but they have one big advantage on their side: time.

If you start saving for your child even before they’re knee-high, then by the time they reach adulthood they’ll have a healthy financial head start.

Whether it's to help fund the cost of university, raise a deposit on their first home, or even start their own retirement fund, it’s worth taking full advantage of those first 18 years as any savings will benefit from compound interest.

What should I consider when investing a lump sum for a child?

When it comes to investing for children, there are several factors to consider before choosing where to put your cash, such as:

• Timescales: How long will it be before you or your child need to access the funds
• Risk: How much risk you're prepared to take to get a better return on your investment
• Tax: How tax-efficient investment plans can make a difference to returns
• Charges: What are the associated costs involved in setting up, managing, and accessing your investment account?

A financial adviser can help you decide on the right investments by explaining any fees, whether it's an easy access account, and any inheritance tax implications.

Junior cash ISAs and junior stocks and shares ISAs

ISAs aren’t just for adults, and parents can open them on behalf of their children to help them build a tax-free nest egg with which to start their adult life.

Parents can choose between a cash junior ISA (or JISA) - which works similarly to a savings account - or a stocks and shares ISA. Here your money is invested in equities but also potentially bonds and other assets, usually via funds, depending on the investments you choose.

Of course, investing in stocks and shares means there's a higher level of risk, and the value of investments can go down as well as up.

However, even though interest rates on cash junior ISAs are currently generous, the long-term growth potential of stocks and shares ISAs is usually better.

Money invested in both types of ISA will grow tax-free and there will be no tax to pay when they take the money out either.

However, unlike adult ISAs, it’s not possible for children to access their junior ISA until they are 18.

It’s important to remember that ordinarily, children are taxed like adults, meaning that if their money isn’t held in ISAs they may have to pay tax on it at some point.

Parents should also be aware that if they are paying into an ordinary savings account for their child and they earn more than £100 in interest a year (or £200 if both parents pay in), they will be taxed at their parents’ rate. This can be avoided by using a cash ISA.

Things to note about JISAs

• There are restrictions on how much you can put into a junior ISA each year and it's significantly less than adult ISAs – the annual limit is currently £9,000 per child and has been frozen at this level until 2030. So keep track of how much you contribute so that you don't go over this limit. (That said, if you have kids and have used up your own ISA allowance, you may decide to top up their ISA to increase the amount of money the family can save tax-free).
• Parents or guardians with parental responsibility can open a junior ISA and manage the account, but the money belongs to the child. Once open, anyone can contribute, so it's perfect for family and friends to gift money over time.
• Children can take control of their account when they turn 16 but cannot withdraw the money until they turn 18. Once you've paid into it, it's legally your child’s money.
• As the money is your child's, when they're able to access it, it's up to them how they spend it. Parents who set up the plan might have had it in mind that the investment would pay towards university fees. Your child, however, may have other ideas about how they want to splash their cash. That means it’s important for parents to discuss family finances with their children and talk about their options, when they turn 18.
• Each child can have one junior cash ISA and one junior stocks and shares ISA, and it's possible to transfer each between different providers.

How much could a junior ISA make?

Assuming an optimistic scenario and a wealthy family, if you were to invest £9,000 a year into a JISA from birth to age 18, and the fund achieved a growth rate of 5%, your child could achieve total savings worth £218,878

This equates to gains of £56,878 on an investment of £162,000.

Bear in mind, however, that stocks and shares are volatile and do not grow at a steady rate.

Although average growth over 18 years might achieve something like 5% per year, this would come in the form of peaks and troughs, including periods of negative growth and dips or big losses.

So, if you have a particular goal in mind (such as covering university fees) you should monitor the JISA carefully in the final few years, and consider transferring it to a cash JISA if it is doing well.

Try not to withdraw it after a slump, as this will ‘lock in’ any losses.

What are some of the best savings accounts for kids?

Child trust fund

Child trust funds (CTFs) are no longer available, but If a child was born between 2002 and 2011, they might have a CTF. If so, you can still contribute up to £9,000 a year into it.

The money belongs to the child, and they can only take it out when they turn 18, although they can take control of the account when they're 16.

There's no tax to pay on any CTF income or any profit it makes. Since April 2015, parents have been able to transfer savings from child trust fund accounts to a Junior ISA.

Junior SIPP

A junior self invested personal pension (SIPP) is a pension designed for a child.

On the face of it, it might seem rather strange to kick off a pension fund for a child who is still in nappies, but it can be a smart choice.

This type of long-term investment could deliver a substantial sum by the time your child is old enough to access it, and they'll be delighted at their parents' foresight and planning.

Currently pensions can only be accessed from the age of 55 (rising to 57 in 2028).

Up until the age of 18, a junior SIPP is managed by a parent or legal guardian, who makes the investment decisions.

And, as a junior SIPP is a long-term investment, more investment risk can be taken to potentially improve investment growth.

Each year, it’s possible to pay in a maximum of £2,880 a year into a junior SIPP, which will be worth £3,600 after basic rate (20%) tax relief is applied.

What makes a junior SIPP special is that most people don't start their pension until they're working.

Starting a pension for your child when they're a baby may add another 18 to 20 year's growth and contributions to a pension pot before its holder even starts their first job.

This financial head start could have far-reaching consequences for a young person including being able to retire with a sizeable pension pot.

For example, if you made an annual contribution of £2,880 into a junior SIPP, tax relief at 20% would mean that a total of £3,600 goes into the pension each year.

This amount would be invested in a fund or many funds, which would generate growth.

This growth would vary (and in some years, there may be no growth at all), but if it averages at 5% a year, by the child's 18th birthday, the pension pot would already be worth around £51,000.

NS&I premium children's bonds

Back in the day, buying premium bonds as gifts for children was popular with parents and other family members.

Holders of premium bonds are entered into a monthly prize draw, where they could win between £25 to £1 million, tax-free.

While this sounds attractive, the reality is that, unlike other savings accounts, premium bonds do not pay interest, which means their value may gradually decrease as inflation reduces spending power – unless, of course, you get lucky and win some prizes.

According to MoneyHelper, on average, one in three people win a prize each year with a £1,000 investment.

If you had £50,000 of premium bonds and, as suggested by Money Saving Expert, average luck, you could win nearly £10,000 in prizes over a five-year period.

Learn more: how to save 10k in a year

Any prizes you do win are free from UK income tax and CGT.

Although you can keep buying premium bonds for your child until you reach the maximum holding level of £50,000, they are generally more suitable as small gifts of £25 or more.

For those worried about losses due to financial crises, it’s worth remembering that premium bonds are backed by HM Treasury, so all the money you invest is 100% secure.

Anyone can buy premium bonds on behalf of a child but must nominate a parent or guardian to look after the bonds until the child reaches the age of 16.

Can I open a bank account for my grandchild?

Yes, you can open a bank account for your grandchild in the UK, providing them with a solid financial foundation for the future.

Many UK banks offer specialised savings accounts for children, allowing grandparents to contribute funds that can grow over time.

These accounts often come with competitive interest rates and features designed to encourage saving from a young age.

To set up an account, you'll typically need your grandchild’s birth certificate and identification for yourself. This thoughtful gesture not only helps secure your grandchild's financial well-being but also teaches them the value of saving and financial responsibility.

Children will normally be able to access these savings accounts whenever they wish, meaning they are less suitable if you want to build a nest egg for them.

If you are paying in significant sums, you will also have to consider the ‘£100 rule’ and whether any tax will be payable.

What are the benefits of regularly saving for a child?

Saving for a child today is a wonderful gift for their future.

Not only can they start their adult lives with some money in the bank, but getting children involved with saving early also helps them learn important lessons about money and help them become financially savvy.

The most important point is the first one: long-term investments benefit from the magic of compound interest.

This results in savings growing like a snowball over time – meaning the more you have, the faster it grows, in a virtuous circle. With 18 years ahead of them, a child can use this time to really make the most of this benefit.

Going back to the junior self invested personal pension (SIPP) – the pension designed for a child – if you (or more likely, your son/daughter) were to continue to pay into that pension after the age of 18, adding to their investments, and assuming growth remains constant, a payment of £180 per month throughout their working life could result in a final pot size of £1 million.

This is quite possibly the most affordable long-term route to a millionaire's retirement.

Should I seek professional financial advice?

Everyone's circumstances are different, and it's true that some people will stand to benefit from advice more than others.

Yet, there are far more people who could reap the rewards of financial advice and avoid the hazards of not doing so.

Financial advice doesn't just cover the big decisions, but the details too. Particularly if you have a large lump sum to invest, a financial adviser can help you find the very best places to make it grow.

If you found this article useful, you might also find out guide on teaching kids about money informative, too!