Why do children get worse returns on Isas than adults?

My four grandchildren all have Junior Isas on a cash basis. These have been repaired, so that the children can only access them from the age of 18.

What surprises me is that savings rates on Junior Isas are not keeping up with the increases in the savings sector. For example, a three-year fixed-rate Isa with Virgin pays 4.35 percent interest, while the best Junior Isa I can find pays just 3.10 percent.

Isas for kids should offer higher interest rates, right? SR Hull, Humberside

Ruth Jackson-Kirby replies: You have identified an anomaly in the savings market. Traditionally, children’s savings accounts pay a higher interest than adult accounts. There are two reasons.

First, banks know it’s a good idea to grab a customer young because most of us rarely switch providers. So catching early makes sense. Second, there are often restrictions on the amount that can be deposited, allowing providers to afford more generous rates.

Yet it is all change. Adult money Isas benefited from rate increases, but children’s bills were overlooked.

Figures from interest rate reviewer Savings Champion show that the best Junior Cash Isa rate two years ago – before the Bank of England even thought of raising rates – was 2.5 percent. In contrast, the best rate an adult could get on their money Isa was 1.51 percent and they would have had to lock up their money for five years to get this.

Today things are very different. Over 18s can enjoy 4.35 percent annual interest on a three-year fixed-income Isa from Virgin Money. But the best rate offered on a Junior Isa is 3.1 percent from construction companies Coventry and Cumberland, although the latter is for local customers only.

Anna Bowes, co-founder of ratescrutineer Savings Champion, says, “The problem is, there are no hard and fast rules when it comes to providers raising savings rates. Although your grandchildren won’t be able to access their Junior Isas until they are 18, their parents can still move the accounts to another provider.’

She adds: “Hopefully Junior Isas will just lag behind regular Isas in terms of fees – and soon banks and building societies will start to push them up too.”

So, when it comes to increasing returns for your grandkids, encourage their parents to keep a close eye on Junior Isa interest rates and be prepared to move plans when a better interest rate becomes available.

It’s also worth noting that your grandkids can each have two Junior Isas: one in cash, the other invested in stocks and shares. The combined deposits into the accounts must not exceed the annual limit of £9,000. More than 70 percent of Junior Isas are cash accounts, but an Isa investment might be a better idea.

Laura Suter, head of personal finance at asset manager AJ Bell, says: “A Junior Isa is the ultimate long-term investment, as the money cannot be withdrawn until the child is 18. Usually a long time to invest means you can take a little more investment risk, as you have more time to weather the rises and falls of the markets. For example, as an investor in the current volatile market, you would probably be much calmer if you knew that you would only need the money in 10 or 15 years.’

Data from AJ Bell shows that an Isa investment can provide a much better return than a cash Isa. Someone saving £50 a month in investment could have built a pot of £17,700 by the time the child turns 18, assuming 5 percent annual investment growth. By contrast, the same amount of cash that Isa earns 2 percent a year would be worth £5,000 less after 18 years.

Suter: ‘Even parents who do not start early investing in an Isa on behalf of a child can make a tidy nest. A parent who starts when their child is ten can generate a pot of £12,000 by investing £100 a month, or £10,500 by saving cash, by age 18. This is based on an average investment return of 5 percent.’

You should discuss with your children whether they are comfortable with Isas’ investment as they will then have to open the accounts for your grandchildren.

While Junior Isa’s rates may be disappointing at the moment, it’s not worth looking at simple kids savings accounts.

The rates are hardly better – the best available is 3.25 percent from HSBC (MySavings account). If the child earns more than £100 a year in interest, it will be taxed at the parent’s income tax rate.