Kids' cash bonus needs help from mum and dad

Some 600,000 seven-year-olds will benefit from a £150m handout from next month. They will be the first to receive a second £250 top-up to their Child Trust Fund from the Government. The cash will be paid directly into kids' accounts, which means it is crucial for parents to look closely at the schemes they have set up for their offspring – and consider whether now is a good time to switch.

Child Trust Funds have been set up for every child born in Britain since September 2002. They are given a £250 voucher which must be put into a savings or investment account and can't be touched for 18 years. When they are seven, the accounts are topped up with another £250, with struggling families receiving twice as much.

"The Child Trust Fund is a great way to build a sizeable nest egg for your children," says Andrew Hagger of Moneynet.co.uk. "Growing up with a savings account means children can see for themselves how small sums can grow and it can encourage them to manage their money responsibly rather than risk running into debt as soon as they start earning."

The Government's hope is that parents, grandparents or family friends will add cash to the Child Trust Fund so that, at 18, the teenager has a sizeable cash windfall which they can use towards whatever they want. Amounts of £100 a month or £1,200 a year can be added to the funds.

There are three types of the tax-free account: investment and stakeholder Child Trust Funds put the money in stocks and shares, while ordinary savings accounts are for cash deposits. Parents are given the right to choose which account they put their children's money into, with the government automatically putting the cash into a stakeholder account if parents don't act within 12 months of their baby's birth.

The problem so far seems to be that even if parents do make a decision of what to do with their kid's windfall, they then give it no further thought. In fact, around half don't even know that they can switch the money to another fund or savings account, according to research from the Yorkshire building society.

Chris Edwards, Yorkshire's head of savings and mortgages says: "We're urging parents who have existing Child Trust Funds to shop around for a good deal.

Just £10 per week saved in a Yorkshire building society cash Child Trust Fund since they were born would be worth approximately £11,740 when the child reaches, 18 but a provider paying just 1 per cent less in interest would mean that they would get just £10,870, an £800 reduction in lost interest over the duration of the fund."

The Yorkshire currently pays 3 per cent on its cash Child Trust Fund, better than any other generally available supplier. Next best is the Earl Shilton building society, paying 2.85 per cent, followed by the Skipton with 2.65 per cent.

However, anyone living near the Hanley Economic building society in Stoke-on-Trent can get an attractive 5 per cent on a Child Trust Fund, but it is only available to people in the local catchment area.

But is a savings account the right decision for a child's fund? No t according to Nick McBreen of Truro-based independent financial advisers Worldwide Financial Planning.

"With interest rates and deposit account returns yielding virtually nothing, parents need to decide whether to stay in a cash savings vehicles or look again at the potential offered from equity investment. It is really important that they remember that the time horizon for the investment may be as long as eighteen years, depending upon how old their child is now."

It's accepted that over such a long time frame, investing in shares is likely to yield better returns, at least historically it always has done so. However, there is no guarantee that stock market investments will continue to provide higher returns and anyone worried about the risk may decide to accept the relatively low rates currently being paid on the cash accounts. In any event, many parents need to start making some decisions, says McBreen.

"With the advent of the second payment, the recent horror stories on the equity market should be a real wake-up call for many parents. Many opted for a stakeholder plan, not necessarily as a positive decision, but because they simply didn't know what else to do or lacked the facility to make any other investment choice.

"One of the big problems at the outset was that the very modest size of the initial Government handout precluded many parents from getting independent advice on what to do with it because of a reluctance to pay fees. These same parents should now be reviewing where their children's CTFs are invested," he suggests.

The fact that this time around there is no voucher – the cash will be paid directly into kids' accounts – means it is easier for parents to ignore the accounts and not make any decision. That would be a mistake, warns Leeds-based independent financial adviser Yvonne Goodwin.

"It's very important for parents to review the accounts to make sure they're happy adding the money to an existing fund. If it's still in the same cash fund as when the child was born, it is important to find out what interest rate it is getting and whether it is competitive compared to other accounts."

If the cash has been invested, parents need to look at how the investment fund has performed. The danger is that a child will reach 18 and discover that their fund has performed much worse than their friends' – because their parent has put the money in a volatile investment fund that happens to be on the floor at the child's birthday, or chosen a savings account with a low rate of interest."

In an ideal world, you'd be able to sit down with a financial adviser and discuss the options, but the cost of advice would be far greater than the actual investment. So it's up to parents to make their own decisions based on whatever information they can glean. Even better, in terms of their child's financial future, is getting into the habit of topping up the fund. "Even if it's only £10 or £20 a month, it will soon add up and can always be topped up in the future with gifts from friends and relatives," adds Andrew Hagger.

He points out that if you paid £30 per month into a cash Child Trust Fund paying 3 per cent for the full 18 years, your child would end up with £9,337. At a rate of 5 per cent it would grow to £11,430. If you paid in £100 per month you would end up with £29,323 at 3 per cent interest and £35,696 at 5 per cent.

Of course, rates on the savings accounts are likely to improve during the term of the funds. Indeed, last October the average rate on a cash Child Trust Fund was 6 per cent with the top deal offering a massive 7.75 per cent. Now the average has slumped to a mere 2.3 per cent.

However, some three-quarters of Child Trust Funds are invested in stakeholder accounts, according to the Children's Mutual, one of the government's registered providers of the accounts. The stakeholder accounts can be an attractive option as they invest initially in stock and shares and then switch over to cash savings accounts five years before they mature. The theory is that you get the benefit of stock market investment and then lock-in the gains.

Adrian Lowcock of London independent financial advisers Bestinvest favours such an approach.

"It's worth considering taking a bit of a risk right now as children getting their second lump sum from the Government still have 11 years to run with their account.

"That's a long time when you could be getting next to nothing in terms of returns from cash savings. You'll need a well-diversified approach to reduce the risk, but there are plenty of decent investment opportunities around for that length of time. And then, as you get towards the maturity date you can move into cash or less risky investments."