Best ways to save for children

The earlier you start saving for future costs, such as school fees and university, the better

Starting to save early on in a child's life for future costs - such as school fees or the deposit on a first home - helps to lessen the pain later, but some savings methods are more tax-efficient than others.

Keeping as much as possible out of the hands of the taxman is key, as regular savings or lump sums invested over many years can become considerable amounts.

For example, saving child benefit (currently £17 a week for the eldest child), like many parents do, could create a sum worth more than £25,000 by the time the child reaches 18 (assuming 5% interest and that the benefit doesn't increase).

Here are pros and cons of the most popular methods for childrenÂ’s savings:

Savings accounts

Any child aged seven and over can open a savings account in their own name. Below that age, parents must do the paperwork.

Interest is paid gross if you complete form R85, which the bank or building society can provide.

Children have the same personal allowance as adults (£4,895 a year) so they will not normally have a tax liability - particularly if the orginal money comes from grandparents or anyone other than parents.

The exception is if the savings come from parents: in this case, interest earned over £100 (£200 if both parents contribute) is taxed as if it were the parent's own money.

ChildrenÂ’s savings accounts often have higher rates of interest than other types of account and many come with incentives such as CD vouchers and piggy banks.

Child trust funds

On top of the vouchers many parents will have already received for investment, parents and others can contribute a maximum of £1,200 each tax year on behalf of each eligible child.

CTF options include both ordinary savings accounts, which generally offer good rates, and stockmarket-based investments (see the help box for a more in-depth guide). The money can't be accessed until the child is 18.

Friendly society bonds

Friendly societies offer with-profits or managed funds that are specifically designed for children's savings and are tax free.

To qualify for tax-exempt status, the investment must be held for a minimum of 10 years. Many parents opt for policies to mature at a milestone age such as 18 or 21.

However, maximum contributions are limited to £270 a year, or £25 a month, and charges can be high.

Additionally, with-profits companies have slashed bonuses in recent years and have been criticised for poor performance.

Stockmarket investing

Stockmarket funds such as unit and investment trusts can be designated for children by simply adding the child's initials to the stockholder name.

This is an informal arrangement that allows the trust to be transferred into the child's name (assuming you still want it to be) when the child reaches 18. However, until that time it will be taxed as the parent's own asset.

Capital gains tax allowances (currently £8,500 a year) apply.

Alternatively, you can set up what is known as a 'bare trust', which allows the child to be named as the beneficial owner of the investment and it will be transferred automatically to them at 18.

Bare trusts can be set up via a solicitor, though some investment fund companies can do this for you, ordinarily at less cost.

Children's bonus bonds

Provided by National Savings, Children's Bonus Bonds are tax free and ultra-low risk. They offer guaranteed rates of interest for fixed terms of five years.

At the end of the five years, the holder can choose to role the bond over for another five years, or until the child turns 21.

There is a limit of £3,000 on investment in each bond issue. One potential drawback is that the child gets control of the money at 16.

Stakeholder pensions

You can take out a stakeholer pension on your child's behalf from birth and contribute up to £2,808 a year. When basic rate tax relief is added, this brings it to the maximum £3,600 a year.

Contributions can be stopped or restarted without penalty and transferred to another provider.

Grandparents and guardians can also set up the pension and pay contributions for any number of children under 18.