One day, son, it will all be yours

Emma Weiss explains how adults can build a gift that their kids will love when they grow up

TEACHING children about money is a vital part of their social education. Good money management is the key to financial security and independence. Useful lessons in budgeting can be taught at the same time as giving children pocket money. But these lessons are short-term and relate to weekly income and expenditure. Children should be taught the merits of long-term savings as well.

Saving for children can also ease the financial burdens on parents. Early adulthood brings the possibility of large financial outlays - for example on higher education, travel, weddings and home ownership. Saving in advance makes these outlays more affordable.

There are many investment schemes that may be suitable for saving long- term money on behalf of a child. Setting up a unit trust as a gift to a child is one. Unit trusts are essentially investments based on shares. As they are subject to the ups and downs of the stock market, they should ideally be held for at least five years, preferably more, to give the best chance of producing better-than-building-society returns. This makes them suitable investments for children.

If a scheme is started when a child is young, a sizable pot of cash can be built by the time he or she is an adult. Unit trusts are also a flexible way to invest. A unit trust can be set up with either a lump sum or with regular payments of as little as pounds 20 a month. You can invest additional lump sums, and stop, start, and change the size of monthly contributions.

A unit trust should be set up with a view to holding on to it for at least five years, but savers do have the option of cashing in early without having to pay a penalty.

This is in contrast to, for example, National Savings products, which are another popular method of saving for children. National Savings' Children's Bonds mean locking up money for a minimum of five years.

Saving through unit trusts on behalf of children can mean tax advantages too. Although children cannot hold a Personal Equity Plan (PEP), unit trusts bought for a child should attract neither income tax nor capital gains tax.

A child is entitled to the normal personal tax allowance - pounds 3,525 per annum. But in practice few children exceed this amount of income in any one year. The same applies to the capital gains tax allowance, now pounds 6,000 in one tax year.

To exceed these tax allowances, a child is likely to have to have perhaps pounds 100,000 invested on his or her behalf in any one tax year. The exact sum would depend on the performance of the investment.

Income on a unit trust is distributed after tax is deducted automatically. Therefore the parent has to reclaim the tax on behalf of the child through the tax office. The appropriate tax form is R232.

As for inheritance tax, giving money to a child using a unit trust should not mean you have to pay tax on the gift. Donations of any size are exempt from inheritance tax if the donor lives for seven years or more after the giving of the gift. No tax is payable if the gift is less than pounds 250 in value or if the donor is not giving away more than pounds 3,000 in total during a tax year. Tax exemptions also exist if a gift does not lead to a reduction in the donor's standard of living.

Under British law children are not allowed to enter a binding contract, which is why a child cannot nominally be the legal owner of a unit trust.

Instead a unit trust bought on behalf of a child has to be initially registered in the adult's name and remain under an adult's ultimate ownership until the child reaches 18 or gets married, whichever is first.

The investment does, however, have to be clearly earmarked for the child's intended future ownership to avoid the risk of a parent facing tax on the returns. This is done by registering the trust with the child's initials after the name of the donor. It is known as setting up a designated account.

For example, say Pauline Pound bought a unit trust for her grandson, John James Pound, the account would be designated under the name of Pauline Pound JJP Acc.

The unit trust remains the legal property of the adult until the child comes of age.When that happens, the normal procedure is for the adult to issue an instruction to the investment manager for the rightful ownership to be transferred to the newly matured adult. This does not normally happen automatically.

To ensure that the tax benefit is obtained, the donor should set up a special trust arrangement. In its simplest form this would be what is known as a "bare trust". This is available from most unit trust companies for this purpose, normally at no extra charge.

It states that although the assets of the unit trust are legally owned by an adult, the ultimate beneficiary is a child. It also states that all the money, together with any capital growth and any income earned, is being accrued on behalf of the beneficiary. That means income will be reinvested and capital gains retained.

Where it is a parent who makes the gift to his or her own child, the trust deed should make clear that the money will not be touched by anyone until the child reaches maturity. Otherwise, in any year where the income on the investment exceeds pounds 100, it will be taxed as the parent's income. This is not necessary where the gift is made by any person other than the parent of the child.

The Association of Unit Trusts and Investment Funds offers free information booklets. One of its fact sheets concentrates solely on how to save money for children in a unit trust as well as other forms of savings and investment.

Autif can also provide a general guide to buying and selling unit trusts, as well as a list of those that are available.

Either phone 0181 207 1361 (seven days a week, 8am to 11pm), or write to the association at 65 Kingsway, London WC2B 6DT. Autif can also provide a sample trust form.

Many unit trusts are bought as gifts for children at birth. Other birthdays or Christmas offer ideal opportunities too.

Thanks and appreciation from the young recipient may be unforthcoming when the gift is given, buthe or she may well be all the more grateful when the investment matures in early adulthood.

q Emma Weiss works for the Association of Unit Trusts and Investment Funds.