Getting children into the savings habit is more important than ever, now that young people are likely to start their independent lives with bills and student debt. Children need to learn to look after their own money – and if you can start them off with a savings plan to defray some of their costs when they eventually leave home, so much the better.

There are a number of things you can do.

A savings account for the child

Many banks and building societies offer special rates for children. Having their own account helps children to learn to manage their money, and they can discover the importance of compound interest as they watch their savings grow.

Many accounts can be opened at birth, and the child can take over managing their own money as they get older. When they enter their teens they will probably switch to a simple card account, so they can withdraw cash from an ATM when they need it.

The best-paying accounts on the high street include the Halifax Children’s Regular Saver, paying a 10% fixed rate for a year. Yorkshire Building Society’s fixed-rate children’s Treasure Bond pays 5.6%. Among the best-buy variable rates are the Chelsea Building Society’s Ready Steady Save, currently paying 5.7%; Yorkshire Building Society’s One Day account, paying 5.65%; Halifax’s Save4It, paying 5.55%, and Nationwide’s Smart account, paying 5.45%.

Don’t forget to look for good deals at your local building society. Nottingham building society has a fixed-rate children’s regular savings account paying 7.5%; Chorley building society’s Foxley Fund pays 7% – although there is no access to the Chorley account until the child is aged 18. Harpenden has a similar account to Chorley’s, but the rate is 5.6%.

Other accounts available from building societies include Norwich & Peterborough’s Family Young Saver, paying 5.55% and Saffron building society’s Ladybird account, paying 5.5%.

If you spot a good rate with a smaller local society it is often worth inquiring if the account is available to savers outside the building society’s traditional area and if transactions can be undertaken by post.

You should also look at other accounts, particularly regular savings accounts that are not particularly targeted at children, as they can sometimes pay more than children’s accounts.

Remember, too, that once a child turns 16 they can have their own cash individual savings account (ISA), although they can’t have a stocks and shares ISA until they turn 18. You can save up to £3,600 a year from next month (April) in a cash ISA, tax-free.

Long-term saving for the future

Parents can help their children by starting a savings plan and putting a little aside each month. The best type of long-term plan is probably one linked to the stock market. Statistics show that, over time, stock market-linked investments perform better than cash based accounts. Of course you may see temporary dips in the value of the account, but you can afford to ignore these if you are saving over an extended term, such as for a decade or so in the run-up to the child’s 18th or 21st birthday, as there will be time for recovery in the event of a downturn.

You can buy individual shares for your child, although children under the age of 18 cannot hold shares in their own names. The usual arrangement is to hold the shares in a “bare trust”. The shares will be held in the name of a parent, with the child’s initials appended to the name in the register to indicate that they are being held for the child.

Buying individual shares is not really the best way to go, because you are not spreading the risk. A better bet might be to invest in a pooled fund, such as an open-ended investment company (OEIC), unit trust or investment trust.

Child Trust Fund

Every child born on or after 1 September 2002 can hold a child trust fund, which is kick-started by a £250 voucher from the Government, or £500 for families that qualify for full Child Tax Credit. The account belongs to the child and can't be touched until they turn 18, which means that children have a fund with at least some money in it to start their adult life.

The advantage of a CTF is that interest and growth are tax-free, and parents, relatives or friends can top up the fund with a total contribution of £1,200 each year until the account matures. At age 16 the child can decide how the money is invested.

Once the child reaches the age of 18, the account matures and he or she can withdraw the money. If the child wishes to leave the money invested, the amount saved up can continue to appreciate by being rolled over into a tax-free Individual Savings Account (ISA)

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You have to choose just one provider for your child’s CTF – you are not allowed to have more than one account at a time. You can, however, switch to a different account provider at any time. There is no charge for switching in this way, but if you have a stocks and shares account the provider may charge you for selling the investments.

Once again, it is probably advisable to save for the long term in a stocks and shares child trust fund.

You can get more information about how to choose a child trust fund here.

If you prefer to stick with cash, some good providers are the Hanley Economic building society, paying 8%; Britannia building society, paying 7.25%; Chorley & District building society, paying 7%; Yorkshire building society, paying 6.8% and the Shepshed and Skipton building societies, both paying 6%.

Tax on children’s savings

When saving for a child it is a good idea to appreciate the tax position. Every child has a tax allowance, just like an adult (in 2008-9 it is £5435). Unless the child comes from an extremely wealthy family, and has his or her own private income, he or she will not be liable for tax because any interest they earn will come below this threshold. This means that, if you set up a savings account, you should ask the bank and building society for a copy of form R85, so that interest can be paid gross. (Don’t worry if you forget to do this – you can reclaim the overpaid tax later, but it is better not to pay it in the first place.)

Dividends and interest accrued on savings outside a child trust find are taxable as the parent’s income if the money invested was given to the child by a parent and these dividends and interest amount to more than £100 (or £200 if from two parents) in any one year. Money given to the child by other parties, such as grandparents or godparents, is not counted as the parent’s income and only becomes taxable if it amounts to more than the child’s personal allowance (see above).

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