The best ways to save for your children – and avoid a tax bill

Saving for your children’ futures can seem like a tall task when the cost of raising them with the basics – food, housing, childcare – already leaves you around £200,000 poorer per child.

But with a little bit of forethought and budgeting, over the first 18 years of your children’s lives you can grow a healthy nest egg to alleviate what may, right now, feel like neverending outgoings.

There are plenty of options out there for parents to get started, from investing to traditional cash savings. In times of high interest rates, like today, traditional savings accounts can offer some healthy returns – but parents will need to watch out for the tax bill that can arise. 

Here, Telegraph Money explains the various savings options available for children, and where to find the best returns.

When should you start saving for your children?

Regardless of how old your children are, or how you’re planning to save for them, the answer to this question is almost always “the sooner, the better”, particularly at the moment. Healthy interest rates won’t last forever – the Bank of England base rate is expected to reduce later this year and, when it does, the headline-grabbing savings rates will simply disappear.

It is also worth taking into account the impact of inflation on cash savings. Particularly during times where inflation (around 9pc) far exceeds the best savings rates of around 4pc at present.

To beat inflation, the experts say, you will most likely have to invest at least some of the savings you set aside for your children into the stock market, as long as you’re planning to invest for at least five years.

If you’re starting from day one, i.e. when your child has just been born, the returns can be impressive. Paying up to the tax-free limit of £9,000 into a stocks and shares Junior Isa, each year for 18 years means your child could, with a 3pc average return, end up with £217,510 when they head off to university.

Nick Onslow, of national advice firm Progeny, said: “Time allows you to make different decisions. If you’re drip-feeding money in over 18 years, I would suggest taking 100pc equity risk versus sticking to a risk-free savings account.

“If your attitude is that you don’t want to lose money in investments, you’ve also got to consider that inflation might erode the return you get. While cash rates are good right now, they’re still not beating inflation”.

The best children’s savings accounts

If you do want to keep some savings in cash, a fixed-term bond could be a good way to make the most of the current high interest rates. As the name suggests, with these kinds of accounts the rate and term are fixed, so you’ll continue to earn interest at the same rate as when you opened the account regardless of what happens in the market.

As of May 18, Halifax offered the best interest rate at 5.5pc on a 12-month bond, according to Moneyfacts. However, this is a mix between a fixed-term bond and a regular saver, as you’re required to pay in between £10-£100 each month. The deposit restriction means you can make up to £33 interest over a year (based on a £1,200 deposit), which works out at an overall return of 2.75pc.

For a longer-term option, State Bank of India has a five-year fixed-term children’s account  paying 4.25pc on balances between £1,000 to £100,000. If you saved a lump sum of £10,000, you’d earn an estimated £2,313.37 in interest over the five years.

Watch out for tax bills

While you’ll be keen to find the highest return you can for your children’s savings, bear in mind that if your child earns interest of more than £100 from money you’ve given them, it becomes taxable and will be added to your income as if it has been earned by you.

If you and your partner both give your children money, then this allowance jumps to £200 interest that can be earned tax-free.

This won’t be an issue if your other savings don’t exceed your personal savings allowance – which is £1,000 for basic-rate taxpayers, dropping to £500 for those who pay higher-rate tax – but if it does, or if you’re an additional-rate taxpayer and don’t receive this allowance, then this added savings interest could add to your tax bill.

The Government introduced this rule to prevent parents from using their children to dodge paying tax themselves.

The £100 limit doesn’t apply to interest earned from money that’s been passed on by grandparents, other relatives or friends, or if it’s in a Junior Isa – which we’ll get to soon.

Premium Bonds for children

One other popular option is to buy Premium Bonds for children. You can invest between £25 to £50,000 on the child’s behalf, and every month they’re entered into a prize draw for a chance to win up to £1m. While instances of children winning the jackpot prize are very rare, it has happened in the past.

Once the child turns 16, they’ll be able to access and manage the Premium Bonds for themselves.

Because children tend to hold Premium Bonds for a long period, there’s more of a chance of winning a prize. As prizes are tax-free and Premium Bonds don’t earn interest, you won’t need to worry about tax, but the money you’ve saved can quickly lose value if you don’t win enough prizes to counter inflation.

Sarah Coles of Hargreaves Lansdown said: “The longer you hold the Premium Bonds, the more their spending power will drop, so if children hold them for a decade or longer, it could make a profound difference.

“The more you win, the more you’ll offset those losses, but there is only a vanishingly small chance of a big prize, and with average luck, you will still lose the spending power of your cash.”

Top-rate Junior cash Isas

To avoid any tax worries, you can open a Junior Isa – or ‘Jisa’.

There are cash Jisas and stocks and shares Jisas available, and all savings interest or investment returns will remain tax-free for as long as the money is held in the tax-free ‘wrapper’. 

You can pay in up to £9,000 in each tax year until your child reaches the age of 18, at which point the account will be converted into an adult Isa they’ll take control of.

As of May 18, Coventry Building Society offered the best rate at 4.15pc for a Junior cash Isa, according to Moneyfacts.

Ms Coles said: “It is so simple to start saving for a child, as Junior Isas are completely tax-free. Savers can choose a cash interest option, or stocks and shares, which in the long-term may well outperform the interest rates on offer today.

“Children cannot gain access to funds until they turn 18 when it reverts to an adult cash Isa, but they can take control of the account at 16.”

Between the ages of 16 and 17, children can hold both a Jisa and an adult Isa. They could save up to £29,000 during this crossover, using up the Jisa and adult Isa allowances.

Invest with a stocks and shares Jisa

While cash Isa rates are the highest we’ve seen for a while, you could get better growth over the long term with investing. If you had invested £1,000 invested in a global tracker 10 years ago, you would have £2,067 today, according to Hargreaves Lansdown, versus £1,263 in savings.

This climbs to £3,354 over 15 years, versus £1,420 in savings, and £6,778 over 20 years, versus £1,596 in savings.

Rachel Springall, finance expert at Moneyfacts, said stocks and shares Jisa may be a more attractive alternative for savers who are prepared for a little risk.

She explained: “It may be tempting to open a cash Isa account, but as children’s savings goals are for the longer-term, parents may instead wish to consider investing.

“Providers out there can offer crafted portfolios based on an individual’s risk profile and can manage a stocks and shares Isa on behalf of the investor.”

However, you’ll need to take fees into account. Nick Hargrave, founder of equity investment firm Moulton Harrox, warns the fees charged by the underlying fund managers can “dramatically” reduce headline returns and are “purposefully opaque”.

Selecting your own investments is therefore the cheapest option, said Mr Hargrave, but acknowledged this was neither easy nor time efficient.

He concluded: “Stock ‘tips’ are generally an unregulated danger, so the lowest cost index tracker within a Jisa ends up being the best option for the vast majority.”

Mr Onslow said low-cost investments would be best, citing funds with annual management charges of between 0.2pc and 0.22pc, and platform charges of 0.15pc.

Fees can be paid separately to the investment, such as out your bank account, so you can keep tabs on the fees versus the returns.

If you take away platform fees, the FTSE has grown around 140pc since September 2011, according to FE Analytics.

Mr Onslow said: “You are beating inflation, and this growth takes into account Greek debt, the Chinese slowdown, the trade war between US and China, Covid-19, and the Russia-Ukraine war.”