setting up a pension for your child
Could setting up a pension for your child be one of the best things you can do for their future?
Have you considered setting up a pension for your child?
You may wonder if that question includes a typo; surely a pension isn’t a savings option for a child?
This article explains how a pension may offer an incredibly tax efficient way to save for your child’s future and provide them with an amazing kick start to their retirement planning.
The most important point to mention before going any further is that a pension is not accessible until age 57 based on current legislation, so for those requiring access to the money, this is not going to be appropriate. If you are wanting to save for your child for adulthood, take a read of my article about Junior ISAs.
Any parent or legal guardian can set up a pension for a child, which automatically transfers to the chid at age 18. A little-known fact is that every tax year your child can receive basic rate tax relief from the government on contributions up to £2,880, even though they don’t personally pay tax! Using our example, you could contribute up to £2,880 net into a registered pension scheme, and at this level the pension would receive £3,600. As another example, you could pay £80 per month into a child’s pension and with tax relief at source, the pension will receive £100 per month. With an instant ‘return on investment’ of 25% before investment growth, you’ll be hard pushed to find a savings option offering the same long-term potential.
As well as tax relief on contributions, any growth within the pension is free of tax, providing the fund with the potential to really snowball.
With the assistance of a financial planner, you will be taken through a fact find and risk discussion to ensure that the recommended investment is appropriate. Monies will be invested, and the balance in the pension can rise and fall. Often risk and reward go hand in hand, with those willing to take more risk, having the potential for greater returns but with a more volatile journey. Considering the significant investment timeframe, having a good exposure to the higher risk assets is often advisable, even if this isn’t aligned to your own risk profile.
Our example below shows just how beneficial investing in a pension can be, especially when combined with such a long investment term.
You start saving into a pension for your 7-year-old, and for 10 years you maximise the contributions upon which you can obtain 20% tax relief (£2,880 per annum). Over 50 years this investment grows by 5% per annum after charges. Over the 10-year term you have invested a total of £28,800, and at 5% growth per annum, this amount could be worth in excess of £330,000 by the time your child reaches age 57.
From personal experience, this is a very popular savings option for grandparents, who as well as saving for their grandchildren’s futures, can also reduce the size of their estates for Inheritance Tax purposes. With tax relief at source, tax free growth, and the ability to reduce the size of an estate and potentially save 40% Inheritance Tax, this savings option is not one to overlook.