With us already into the second month of the year, many of us will be thinking about the kind of financial challenges our children may be face in the future.
Depending on their current age, you may already be thinking about ways to help them with the cost of their education, or with getting on the housing ladder.
But you might want to think long term and start thinking about their pension.
It may seem a strange thing to do. Most of us wait until we start working before we have any thought about financial planning for our retirement.
But at Continuum, we believe that pension saving is becoming an increasingly popular choice for generous parents and grandparents.
How a child’s pension works
Most of us don’t have any cash to save while we are still babes in in arms – but we can have a plan set up on our behalf from the day we are born.
All pensions currently attract generous tax relief, which is why they may be a particularly effective investment. Children do not generally earn an income to be taxed, but a child’s pension can still receive a concessionary 20% tax relief. A pension arranged for a child can be funded up to £2,880 year, so the taxman will add an extra £720 a year, boosting the pension pot to £3,600 each year (as per the Tax year 2019/2020).
Thanks to the tax reliefs, a pension can be one of the most rewarding investments it is possible to make – however young you start.
It is currently possible to pay in more than £2,880, but anything in excess won’t benefit from the government’s generosity. The figure seems to have been carefully chosen. It is below the annual £3,000 gift allowance for inheritance tax, so it should not cause problems with HMRC further down the line.
When your child reaches 18, they take ownership of the fund. They can sit back and watch it grow, or continue to add to it, knowing that their pension is already off to a very good start.
The big advantage of starting young is that time really is money. Starting young gives cash more time to grow, so that even with a conservative investment strategy, compound interest can build a sizable pension plot.
If you were able to fund a pension from birth until the time your child started full time work, they could have a steadily growing pension pot even if they can never afford to make a payment into it themselves.
Quite how large it could grow would depend on exactly how the sum is invested, but simply making the maximum contribution for 18 years would mean a sum of £64,800. With professional management, and half a century of compound growth, this could possibly grow to several hundred thousand pounds by the time they are ready to retire.
The actual sum would be larger still if they continue to make contributions themselves while they are working. Obviously, inflation could eat into the value of the pot, but whatever the future holds, a pension should give your offspring a head start on financial security.
There are of course other ways to be generous to your younger generation, such as a Junior Cash ISA – but the pension has the big advantage of being safely locked away until retirement age.
How do you set up a child pension?
If the idea of setting up a pension for a child appeals, it is simple to arrange. Many insurance companies and pension providers offer basic, low cost stakeholder pensions, with capped fees. If you are a confident investor, you could consider a SIPPS approach, which would allow you to pick investments yourself.
But whatever approach you choose, you will want performance and security for your young pension holder. To get the help you need, professional advice is essential – so please contact us at Continuum.
The information contained in this article is based on the opinion of Continuum and does not constitute financial advice or a recommendation to suitable investment strategy. The tax rates referred to are based on our understanding of current HMRC rates. Taxation is subject to individual client circumstances. You should seek independent financial advice before embarking on any course of action.
The value of your pensions and investments can fall as well as rise and you may get back less than you invested.
Equity investments do not afford the same capital security as deposit accounts
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