The Child Trust Fund - what do I need to know?

Every child born on or after 1 September 2002 will receive an initial lump sum payment of £250 (or £500 for families that qualify for full Child Tax Credit) from the government. A voucher will be sent to the Child Benefit claimant, usually the parent, which is then used to open a Child Trust Fund (CTF) account with the provider of their choice, likely to be a bank, building society or investment company.

Opening a Child Trust Fund account

Once you receive your CTF voucher, you can choose which type of account to open with it. The three types of CTF accounts are:

• savings accounts - which provide a safe, risk-free home for your child's money. You are guaranteed to get back what you put in plus some interest.

• share or equity-based accounts - which invest in listed companies. These carry risk because the value of the shares can fall as well as rise. The provider will also charge for managing the shares and the costs are likely to be a percentage of the CTF's value.

• stakeholder accounts - are an investment vehicle designed by the government. Your child's money will be invested in shares but the account is run using special rules which reduce the risk and limit charges to 1.5% per year, making them more flexible and better value. The risk level of the investments is reduced when your child reaches the age of 13 so that it is not exposed to any sharp stockmarket falls in the last five years before it matures.

You must choose only one account for your CTF contributions as the rules do not permit you to spread the money between several different accounts. But you can switch between accounts if your objectives change or you want to earn more interest. There is no charge for switching in this way but if you have a stocks and shares account, your provider may make a charge for selling the investments. You will need to shop around for the type of account which offers a level of risk you understand and feel comfortable with. Make sure you know just how a particular account works before you sign on the dotted line.

Topping up a Child Trust Fund account

Although the government is providing the initial contribution, it is keen to encourage parents, grandparents and other relatives and friends to pay into CTFs. A maximum of £1,200 can be saved in your child's CTF account every 'contribution' year which starts from your child's birthday each year. The only exception to this is during the first year when the start date for contributions is the date the account was opened and the end date is the day before your child's next birthday. The £1,200 limit still applies so if your child has a birthday shortly after the CTF account has first been opened, you will need to act quickly to make the most of the first year's contribution limit. Most providers will accept contributions via cash, cheque, standing orders or direct debits.

The account is usually opened by a parent or guardian and then managed on their behalf. This includes keeping statements and documentation safe, paying money in, notifying the provider of any change of address and switching the account if it is in the child's interests. Once a child reaches the age of 16, they will become the registered contact for the account and must contact the provider to arrange this. Annual statements will be sent to them and they will have the chance to switch the account type or provider if they wish. When they reach the age of 18, they will have access to the money.

How a Child Trust Fund could grow

The original £250 contribution and the follow up of £250 seven years after will grow to around £1, 410. But once you factor-in the driving lessons and average university debts of £11,000, this wont go far, although it is certainly better than nothing.

Research carried out by Virgin Money revealed that on average, parents are prepared to contribute £38 a month into a Child Trust Fund. That, plus the Government's contribution could result in a pot worth more than £14,000 at age 18. If parents could save the equivalent of Child Benefit each month they could expect the final sum to be closer to £27,000, presuming (an optimistic) 7% annual growth.

PricewaterhouseCoopers, the accountancy firm, has calculated that, based on a £500 payment from the government, £1,000 from family and friends in year one, and £1,000 every subsequent year thereafter, plus an investment return of 3% (above inflation and after taxes and charges) a CTF would be worth around £26,000 on the child's 18th birthday in today's money.