How to save for your child’s future without a lot of money
Being a parent is a hard job. In addition to the never-ending workload of washing, tidying, school runs, after-school clubs, nursing and trying to keep bad influences at bay, you are required to instil important lessons that will help your children develop into thoughtful, considerate and well-rounded adults.
The content of many of these lessons is subjective, but not all — manners, reading, writing and basic arithmetic are among the things that almost everyone in our society agrees to be important for children to learn.
Curiously, how to manage finance receives less focus, and although many parents and certain schools teach basic finance, until now it has not featured in the national curriculum. This is peculiar because money is so prominent in all of our lives; from salaries to savings and mortgages to credit cards, we all need to have at least a basic understanding of managing our money. Yet, as a recent article in the FT Adviser explained, “[u]nderstanding of financial terms is still low across the general populous, [and] more people find it easier to explain the offside rule than they do a pension” while others stated they “were more able to explain the ‘big bang’ and particle physics” than income drawdown.
As of this month, financial education will be in the curriculum for all maintained schools in England for 5- to 16-year-olds. This will help explain the importance of good money management, and hopefully encourage children to be more receptive to thinking about saving.
In addition to teaching children how to manage money, one of the best things a parent can do is create a fund for their future. This can be for general savings, a house deposit, university or even retirement — or you can hand it over to your child when they reach a certain age and let them decide how to use it. That would require strong confidence in how well you taught them money management skills though!
But I can’t afford to start a savings fund
If that’s what you’re thinking, you are not alone — no doubt the main concern parents have about starting a fund for their child is not having enough surplus money to put into it. But don’t worry! This money will be growing over decades, so you don’t need to funnel huge sums into it. Here’s how you can do it — but note that this is not financial advice or a how-to guide, but for informative purposes:
1. Start early. The younger the child when the fund starts, the more time compound interest can work its magic. (Compound interest is when interest accrues on interest, which over time can build very considerable pots of money.) Money Advice Service provides the following example to demonstrate how effective compound interest is: with a 6% investment growth, if you save £100 a month for 40 years you would have £190,000, but if you save £200 a month for 20 years, you would have only £90,000.
Since 1918, the UK stock market has seen long-term returns of about 11% per annum — almost double that of the above example. With that rate, if you put £25 a month into a tracker fund when your child is born and leave it there until they turn 21, it would be worth £24,064 and your cost of investment will be just £6,300. If you then hand it over to your child and they leave it accruing at the same rate until they turn 60, it will be worth £1.4 million. Not bad for an investment of less than £7,000!
There is no substitute for time, and putting more money away later won’t make up the difference. If £100 a month was invested between the ages of 21 and 60, almost £47,000 would have been put aside but the fund would be worth £696,991. Just £25 a month — which is currently less than a tank of petrol — can make a considerable fund for your child.
2. Consider the merits of different funds. The temptation may be to nip into your local branch and open a standard savings account, but consider a fund like a menu — you don’t settle on the first item for dinner, so why would you settle for the first account you find?
ISAs are a popular savings vehicle for adults, and under 18s can have their own Junior ISAs provided they live in the UK and weren’t entitled to a Child Trust Fund (the rules change in April 2015 so those with Child Trust Funds can move them to a Junior ISA). The two types of Junior ISA are cash or stocks and shares, and the main benefit is that they are tax-free on interest (for cash accounts) or growth and dividends (in stocks and shares accounts). This allows the compound interest to accumulate over decades without any going to the tax man — although he does take his share when money is removed from the fund.
If you’re worried about your child knowing a fund exists and nagging relentlessly until you let them have, depending on their age, a paddling pool/mobile phone/motorbike, Junior ISAs typically don’t allow money to be removed until the child reaches 18. It’s like the person who created them could read parents’ minds. However, do consider that money can’t be moved between a Junior ISA and a regular grown-up ISA (but Junior ISAs do turn into regular ISAs when the child turns 18), and the annual limit is currently only £4,000 — compared to the £15,000 adults can squirrel away. So if you want to keep the money locked away past their 18th, or intend on saving more than £4,000 a year, you might want to consider opening a regular ISA — just don’t spend their money!
An alternative to an ISA is a private pension. This usually doesn’t spring to mind when considering saving for children, but it can be a great option. The money is locked away until they turn 55, so there’s no chance of them spending it in advance, and with Britain facing a daunting pensions time bomb it would ensure your child has at least an excellent starting point for retirement, which can be boosted by their own savings and investments.
Pensions benefit from tax relief — even for people who don’t work, such as children (don’t tell them that though, in case they decide to stay on your couch forever because ‘retirement is already sorted’). It’s applied at the basic-rate of 20%, so if you put £2,880 into the pension fund the government will add another £720. That’s free money! Your building society wouldn’t be so generous. It may not be enough for them to completely retire on, but it should provide comfort.
3. Go for the long haul. A child’s saving fund needs to be a long-term investment, so there’s no point only contributing for a couple of months or closing it after five years. Even a single payment of a few thousand pounds will grow to a considerable sum in 20 years, so it’s important to ‘forget’ about the money once it’s been saved. That’s an added benefit of Junior ISAs and pensions — the money is locked in, which totally removes any temptation to withdraw some.
As stated above, when it comes to saving, it can’t start too early nor last too long. As Kara Gammell explained in her article for The Telegraph:
“If, instead of starting the pension at birth, your child starts contributing once he or she starts work and saves the same £3,600 every year from the ages of 25 to 65, they will end up with a pension pot worth only £590,600 before taking inflation into account, rather than £1.8 million. This is despite them saving for 40 years instead of 18.”
The real benefit of having a fund open for decades, maybe even 50 or 60 years, is that you can invest in the higher risk funds. The prolonged length of time will reduce the associated risks, and offer the greatest opportunity for higher returns. This is indeed an ill-advised strategy for shorter periods, such as five years, but over five decades you can afford to pay more serious consideration to this strategy.
You can also consider emerging technologies and nations, paying thought to what developments may occur over the next 20, 30, 40 or 50 years. Of course, you’re able to reduce or increase the risk levels when you want, so if you wake up in the night in a cold sweat because of your choices, you can simply adjust it (probably best to wait until the morning though).
4. Cut back on outgoings. This one is just about common sense — don’t live off cold baked beans as you shiver in your dark living room just so you can put money in your child’s savings fund. It’s important that they have food, heat and light in their formative years. But if you’re spending a small fortune on a subscription TV package and only watch the channels you get on Freeview, cancelling that subscription will give you a good sum of money to put into the fund. Wielding an expensive phone on a hefty contract only to send a few texts and browse the Internet? You could opt for a cheaper model at the end of the contract, or keep the handset and switch to a SIM-only deal. Can you walk more and cut down on your petrol expenses? Or shop in the evening when many supermarkets have reduced the prices of various fresh products? Eat at home on a night you usually go to a restaurant? Any of these things can free up a good chunk of money, and doing all of them can really boost your wallet, giving plenty to put into your child’s saving fund while having some left over for yourself.
Not sure how much of a difference a small sum can make? Consider this example: if you spend £6 per day on lunch at work, you could be spending close to £1,500 each year. If you saved that for 21 years, you would have £31,500 — a considerable sum in its own right, but when you factor in the compound interest it’s enough to make you need to sit down — and that’s additional money to the rest of your fund.
5. Monitor the interest rates. Don’t run away at the thought of this! It may sound boring, but it’s not difficult. A lot of accounts have special introductory rates, which then drop after 12 months. To maximise the fund, you can move the savings from one place to another, earning higher interest. Respected comparison sites abound on the Internet these days, so you can check the latest rates within minutes and then decide if you want to move the money or not. Remember, even a single extra percentage can make a big difference over the years, so it can really pay to periodically check your money is in the most rewarding place.
Simple, right? It is, and that’s how it should be. It’s a common tendency to overcomplicate finance, and while facets of it can certainly take some getting used to, there is plenty that doesn’t take too much time to get started on. Creating a savings fund for your child’s future is one of them.
It should go without saying that you should not put yourself in difficulty by religiously contributing to the fund. If you have a tight month and can’t afford it, don’t worry. If you lose your job and need to refocus your budget to cover the absolute essentials while you get sorted, don’t feel guilty. The aim is to provide what you can when you can, and just doing something at all will provide a great gift to your child in the future.
To really help with their future though, teach your child about money. Getting them involved is the easiest way to get them excited to learn, especially if they can watch their own money grow in a separate savings account. You may find them washing the car every week so they can add some more to their pot.
If they learn the value of money as they grow up then they are much more likely to be responsible when you give them access to their fund — using it wisely or adding to it rather than buying first class tickets to Las Vegas for all their friends.
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