Three Great Reasons to Start a Pension for Your Child
When you say the word ‘pension’ to most people they see it as something to worry about in the middle age. Who wants to be thinking about getting old and what retirement might look like when you’re young? The problem is that for most people, by the time middle age hits, it’s already way too late to build up a decent pension and have enough for a comfortable retirement. The Government has known for a long time that we are saving too little for our old age and has recently introduced ‘auto-enrolment’ pensions to try to address this. We see this as a positive step but it is unlikely to be enough to bridge the ‘pensions gap’.
Today, many young people are burdened with huge sums of personal debt thanks to massive increases in university tuition fees, soaring house prices (and therefore deposits) and suppression in real wage growth. There are few people in their 20’s who are in a position to start funding significant amounts into their pension as they often have bigger financial priorities.
But what if they could start saving into their pension even earlier? Not when they start work, not after leaving university but when they were a young child? Many people are unaware that anyone can start a pension – that means even a child or a newborn baby for that matter. A pension can be started at any age, and not only that, but the same tax breaks are available for kids as they are for anyone in work.
There are around 18m children in the UK under the age of 18 but HMRC figures show that just 60,000 of them have a pension. That’s a tiny fraction and maybe part of the lack of update in children’s pensions is simply down to a lack of awareness.
If you are thinking about putting some money aside for you own kids or maybe your grandkids, it’s worth taking a good look at whether a pension might be the best way to go. Anyone can put money into a child’s pension so it can be a really good way to build up a long-term savings pot for them. When your child reaches 18 they take ownership of the pension and can keep adding contributions or leave the savings invested to grow throughout their life.
There are some great features of pensions that make it a really attractive way to invest for children so let’s dive in.
Three great reasons to set up a pension for your child
Access. Many would view the fact that a pension can’t be touched until the age of 58 as a disadvantage but it can also be seen as one of the biggest advantages. When you invest money for children, one of the biggest worries is what that money will ultimately be used for. Using an alternative vehicle such as a Junior ISA, means your child can get their hands on their money when they are 18. We can all probably think back to our 18 year-old self and know that sometimes the best decisions aren’t always made at this age. With a pension, you will know that they money you put away will be there for the long-term and will be part of securing your child’s financial well-being into their latter years.
Tax relief. Many people are surprised that a child can get tax-relief on pension contributions in the same way as an adult. Every child can put away up to £2,880 a year into a pension with the government providing an extra 25% on top, so they get £3,600 each year. That’s 25% free money that can boost the value of a pension massively. Not only this, but as there is a limit of £3,000 a year on gift allowances for inheritance tax, even the maximum added to a kids pension will be treated as a gift so will fall out of your estate. N.B. Technically speaking, you can put in any amount into your child’s pension but the tax-relief is only available on the first £2,880 so anything above this is probably better off in something like a Junior ISA.
Returns. There is an old adage that “compound interest is the most powerful force in the universe”. That’s a pretty big statement but Einstein was probably well placed to judge. The fact is that investments tend to grow over time. You get the initial growth, then you get the growth on the growth and so on. Before long, even a modest starting sum can accumulate into a sizable fund through the power of compounding. By starting an investment for a child and ensuring it can’t be touched for at least half a century, you are guaranteeing this compounding will take place – you are ensuring a long investment term. Let’s look at a couple of simple examples. We know that a pension started for a child today can’t be touched until at least the age of 58. This may rise if the government chooses to up the age at which people can access their pension as life expectancies rise. So, let’s assume a term of 55 years and investment growth (after charges) of 7%.
- A single annual contribution of £2,880 could be worth around £150,000
- 10 years of annual contributions of £2,880 could be worth nearly £1.5m
Now, inflation will reduce what those sums can actually buy and your child will probably be taxed on three-quarters of their pension pot as they draw their money out, but that could be a pretty handy nest egg for your little one to enjoy one day.
Are there any downsides?
Well, we’ve already touched on one – access. Whether you see this as an upside of pensions or a downside depends on your point of view, but your child might not thank you when they turn 18 and can’t just blow their money.
The other potential downside is the political angle. With anything that is focused on the long-term, there is always the risk that the goal posts are moved.
The Government continues to be very generous to pensioners, allowing 25% of their fund to be taken as a tax-free lump sum and currently offering unrestricted access to the whole pension pot once pension age is reached. The way tax-relief current works (the bonus the Government adds to each pension contribution) is also pretty generous and may change in the future as public finances get squeezed.
So should this put you off? We don’t think so. Political risks exist in all walks of life and they are rarely a good reason not to do things – on the chance that something might change at some future time.
Isn’t a Junior ISA a better option?
The obvious choice for most parents who want to save for a child is a Junior ISA. These have been incredibly popular since being introduced in 2011. They are almost seen as the ‘default’ choice for parents wanting to save for their children. Let’s compare how a Junior ISA stacks up against a pension:
What to invest your child’s pension in
The key thing to remember is that a pension is just a ‘tax wrapper’. In other words, it’s just a product with specific rules. Rules like how much you can put in, take out and the tax-relief situation. Underlying a pension can be almost any kind of investment. In fact, whether you have an investment bond, ISA, general investment account or pension, nowadays, you can pretty much hold the same kind of investments.
This can be cash, stocks and shares, investment funds, peer-to-peer lending or any other investment that is available through your chosen pension provider. We suggest looking for a pension provider that offers a broad range of investment options as your child’s needs are likely to change as they go through life. You also want to try to find a good value pension company who don’t levy high charges. Remember that you can always switch pension providers at any time so you’re not locked in – although you need to avoid companies who insist on ‘exit charges’. Whatever decisions you take, once your child reaches 18, they will be in control and can do pretty much what they like with their pension pot; everything, that is, except spend it – not until they are 58 years old at the very least.
In terms of the investments to choose, the usual adage applies – don’t put all your eggs in one basket. Try to find a good mix of investments to spread your child’s risk. You might be somewhat ‘risk adverse’ yourself and more comfortable with investing in cash, but remember, you child has more than 50 years to ride out any ups-and-downs in markets, so you can probably afford to be fairly adventurous in the types of investments you select.
If you’re in doubt about which providers will offer the best pension products for your child or how to put together a sensible investment strategy, speak to an independent chartered financial planner who will be able to give you expert, impartial advice.
Pensions can be a great way to save – at any age. Anyone can start a pension and that includes children. There are pros and cons of saving into a pension for your child but it is a route that is well worth some serious consideration. Setting up a pension for a child means you are giving them a great financial start and they will have a financial base all the way through their working life.
Finances can become strained at any age. Some young people desperately need money in their early adult life to pay for university, a house, children or a wedding and some funds could come in handy, but the real challenge that most will face is in later life. As a society, we are massively under-investing for our old age. As we all live longer and longer, retirement becomes more and more expensive. By thinking ahead now, you can help your child learn about the benefits of long-term investing and start them on the journey towards a comfortable and happy retirement when the time comes.
It might seem strange to think about your young child as a pensioner, but one day they will be. Your decisions now could help shape what type of retirement your child has and how financially secure they feel throughout their life.
If you would like to talk through your options when it comes to investing for children, please contact us to arrange a free consultation.