Consuming Issues: Helping children to start saving

Parents and grandparents love to save for children. It gives them a stake in their future as does the thought that the cash can help give them a head start in life. But choosing the wrong savings account could cost junior hundreds of pounds.

Putting £100 into Bath Investment's instant access Future Builder account for instance would grow to £207.89 after 15 years, yielding £107.89 in interest, assuming the rate remained at its current 5 per cent. But put the same £100 into Cheltenham & Gloucester's Young Investor would yield interest over 15 years of just 75p. That's not a printing error. The account currently pays a paltry 0.05 per cent meaning the total balance after 15 years, assuming the rate remained the same, would be just £100.75.

That neatly demonstrates that the actual interest rate paid can make a really substantial difference even on relatively small amounts saved. Given that little Johnny may stay with the same account for his entire childhood, which if opened in infancy, could be for up to 18 years, surely it makes sense to shop around for the best deal available?

Also bear in mind that just because an account is competitive at the time of opening does not mean that it will remain so. The lesson here applies equally to adults and it is that you need to review your account's competitiveness on a fairly regular basis. Be prepared to move the account elsewhere if and when a more competitive deal becomes available.

But it's a given that if you're a six-year-old then the chances are that you will be more interested in buying sweets, or maybe something from the littlest pet shop range, rather than saving money. Faced with that thought it's obvious that children need to be encouraged to save in order to set them up with the good habits that they will need in later life. Ideally get them involved in the decision-making and get them to save an agreed proportion of their pocket money as a matter of course. If a child can see their savings balance building up over time it will act as an encouragement as they progress towards their savings goal.

Most banks and building societies offer savings accounts for children so there is a lot of choice available. However, many children are restricted to the account offered by whatever branch happens to be in their local high street, or some may be luckier and have a choice of several different branches. As with adult accounts, the interest rates on offer vary considerably.

One difficulty in involving kids in the decision-making process is that children will be attracted by the free gifts given on opening an account. Banks and building societies know that a free teddy bear or moneybox is all that it takes to sway a child but, frankly, it is better to buy them a similar gift separately and then choose the savings account on the basis of the interest rate offered. Explain to them that the extra money they make in the better-paying account will more than cover the cost of the new toy.

Some 21 of the available children's accounts offer a freebie. Typical is a moneybox but the Shepshed Building Society weighs in with the choice of either a model van or a teddy bear. The highest paying account that offers a free gift is currently the Holmesdale Building Society's Young Saver which has a rate of 2.35 per cent and offers a wooden savings box, a wallet or a £15 gift card depending upon age. But that rate is still poor compared to the current top rate available from Halifax's Children's Regular Saver at 6 per cent.

There are other issues to bear in mind when choosing a child's account. Many parents may prefer that their child cannot make withdrawals without a parent countersigning. The parent generally has to sign for all withdrawals for the under seven's but even above this age many children's accounts can be operated by the adult on a trustee basis to restrict the possibility of savings being frittered away.

At the age of eleven there are a number of children's accounts from the larger banks and building societies that offer a cash card facility. This can help the child get used to managing their own finances.

Under the current tax regime children can earn up to £6,475 in a tax year without having to pay tax. So, assuming the child's income will be less than this amount, fill in an HM Revenue and customs R85 form to ensure that gross interest is earned. The bank or building society will supply the form when the account is opened. However, be warned, if a parent or step-parent gives money to their child and it produces more than £100 gross income a year then the whole of the income from the gift is taxed as the parent's income.

Child Trust Fund accounts have been available since 6 April 2005 for children born on or after 1 September 2002. Under the CTF scheme each child gets a £250 voucher – depending upon household income some get an additional £250 – with a further £250 voucher payable at age seven. There are a range of CTF funds available and they are generally equity linked or cash-based.

Saving is definitely a good habit to learn but taking some time to compare the accounts available for the best return should be part of the decision because the interest rates on offer can make a considerable difference.

David Black is Banking Specialist at Defaqto