The government this week confirmed that it will launch tax-free ‘Junior ISAs’ to encourage parents to save on their children’s behalf and to fill the gap that will be left by the removal of the Child Trust Fund scheme.
The Labour government’s CTF regime was scrapped by the coalition government within days of it taking over the reigns and will cease to exist from the end of 2010. It is hoped that the new regime, confirmed yesterday, will pick up the gauntlet in encouraging parents to save for their offspring's future, particularly as it comes at a time when many families and students are concerned about rising university tuition fees.
There are a number of important differences between the CTF and the Junior ISA regimes, and some key details are still missing, but initial reactions to the news are generally positive.
The former CTF regime saw parents gifted with a lump sum ‘starter’ to invest for their children, and additional contributions depending on their circumstances, but in the name of austerity the Junior ISA regime will simply be a tax-free wrapper in the same way as an adult ISA. Some commentators have already expressed concern that this will mean lower-income families are less likely to save or invest for their child’s future in this way. “This proposal does not seem to offer much more to investors than is already available through investment trust saving schemes,” commented James Budden, Marketing Director for Wealth Management at Baillie Gifford. “People can already use the ordinary ISA route to save for children,” he noted, adding: “The key to the CTF was the government contribution, and with that removed I fear this is an olive branch to appease the lobbyists.”
But the introduction of a new scheme presents the opportunity to not only simplify investing on a child's behalf but also to do so at a lower cost. Morningstar’s Director of Investment Trust Research points out that there’s scope for Junior ISAs to be a cheaper way to invest compared with their predecessors: “Because the previous government stated the maximum annual management charge was 1.5%, most providers charged that amount. Hopefully the new structure will allow cheaper funds.”
The word “hopefully” is an important one—there are several details that have not yet been disclosed. The government has confirmed that it expects Junior ISAs to come into existence in the autumn of 2011, that there will be an annual cap on how much parents can place in these tax-free wrappers, and that the child won’t be able to access the funds until they are 18. What it has not unveiled, however, is what this annual cap will be, whether currents savings and investments held in a CTF can be transferred into a new Junior ISA, and whether, as Jackie Beard notes, there will be guidelines as to what fees providers can charge.
The administrative restrictions on CTFs put a lot of would-be investors off, and those that did make use of them often found they had little choice but to invest in tracker funds due to restrictions on many other investment products. Ian Sayers, Director General of the Association of Investment Companies (AIC) is a staunch supporter of reducing the complexity of parents’ options for savings and investment. “It is important that the transition from Child Trust Funds to the new regime is as straightforward as possible,” he commented earlier today. “As such, Child Trust Funds should be rolled over into Junior ISAs with the minimum of fuss, to avoid unnecessary bureaucracy and compliance burdens for product providers. Given that costly administrative systems were established for CTFs these should be used as the basic operating model for Junior ISAs, stripping out those elements that are no longer needed.”
Morningstar’s Jackie Beard is in firm agreement: “I concur totally with Ian Sayers of the AIC regarding the transfer of existing CTFs into these new vehicles to keep administration simple—this will also open up the investment options.”
Jackie Beard’s first child was born not long after CTFs were launched, at a time when the fund options were very limited as so few providers were prepared to deal with the raft of administration involved. “I would welcome the opportunity to change funds and would then consider making regular monthly investments into my child’s ISA,” she says. The relative cost and minimum payment levels associated with closed-end funds versus their open-ended counterparts present a particular opportunity: “This is where investment trusts come into their own—I can make small monthly additions, benefit from pound-cost averaging and not be committed to a minimum monthly payment of £100, as is the case with most open-ended funds.”
Jackie Beard is not the only one advocating the use of investment companies in tax-free wrappers such as the proposed Junior ISAs. “The move to provide a more simple and straightforward way for parents to save for their children’s future will hopefully prompt more people to realise the benefits of using investment trusts ISAs as an effective investment vehicle for their money,” James Saunders Watson, Head of Investment Trust Sales and Marketing at JP Morgan Asset Management said.
In light of recent developments, many young families will be thinking about the rising costs of further education. Assuming that the government enables the straightforward transfer of CTF assets into Junior ISAs, and ISA providers as well as fund providers keep their fees low, the Junior ISA should prove a convenient tool for parents to sock away cash and invest for such events in much the same way that our North American cousins do. And with sensationalist headlines pointing to university fees hitting US-like levels in the not-too-distant future, this seems like a prudent idea.
Whether you are a fan or not, the introduction of Junior ISAs is set to save the government half a billion pounds a year compared to the CTF scheme. ISAs for more ‘mature’ savers currently come with the annual limit of £10,200 that can either be fully invested in stocks and shares, or half the total can be saved in cash. Until they cease to exist at the end of the year, no more than £1,200 can be paid into a CTF each year.
A final word from the AIC’s Ian Sayers and one on which we at Morningstar firmly agree: “As well as providing the opportunity to save, the government should also recognise that education remains crucial so that parents are aware of the need to plan early in order to secure the future financial welfare of children.”
Visit Morningstar’s ISA Centre for more information on investing in these tax-free wrappers.
