Fool's Eye View

[ September 4, 2000 ]

A Pension for Your Child?

By Nigel Roberts (TMFNigel)

Chippenham, Wiltshire -- Back in July vincenorris posted a message on the Investing for Children discussion board, saying:

"When the new Stakeholder pensions become available in April 2001, they apparently will have no lower age limit and will not require the beneficiary to be earning. Therefore, I am seriously considering starting a stakeholder pension for my 5-year-old daughter and either investing a lump sum, or feeding in the monthly child allowance."

My initial reaction to this was to dismiss the idea. After all, I have a strong aversion to pensions; I see them as very inflexible products which ultimately result having to buy a dreaded annuity, and so I am making provision for my own retirement in various other ways.

But how can a child have a pension?

In the past you had to be earning money and paying tax to be able to benefit from having a pension. But all that is about to change. When the new stakeholder pensions go on sale next April, it will no longer be necessary to pay any tax in order to receive basic-rate tax relief on money paid into these plans. However, the Government has make it clear in its consultation document on stakeholder pensions that there will be no lower age limit for making contributions. This means that you can make contributions for children. The critical issue is that even though a child may not be paying income tax they will be able to benefit from an income tax rebate into their stakeholder pension. This means that an investment of £100 into the stakeholder pension fund would actually cost you only £78.

Readers of the Fool's Guide to Investing for Children will know that I am currently saving and investing for my children. One of the primary sources of funds for this is the Child Allowance that the Government so kindly pays to us. Imagine what would happen if this money was invested into a stakeholder pension for the benefit of my children; currently it is £15 a week for the first child and £10 a week for any subsequent child. So, basing this on our first child, Catherine, if we invest £15 a week, or £780 a year, after grossing this to take advantage of the tax rebate of 22%, we would get the equivalent investment of £1,000 a year. Now imagine if we had been able to start investing this when she was born until the child benefit finished at the age of 18 in a stakeholder pension, and she then did not make any further contribution, and this grew at the rate of 10% (the average market return since 1900) until she retired at the age of 50; how much would it be worth? For a total investment of £18,000, which will have actually cost us only £14,040, how much could this grow?

At the age of 18, and assuming a 10% annual rate of growth, and a 1% annual management fee, then Catherine's fund would be worth £45,000. If she stopped contributing and left this to continue growing at 10% a year less the 1% annual charge, then by the time she was 60 years old the fund would have grown to £2,380,000.

Even allowing for inflation over the next 50 years this is still a sizeable fund and certainly has the potential for her to be guaranteed a comfortable retirement. Based on current annuity rates from Friends Provident this would produce an income of £174,000 a year. Assuming an inflation rate of 4% for the next 50 years, is equivalent to an annual income today of about £17,300.

Is this too good to be true?

All of this sounds very attractive, but of course there are potential problems.

1. Buying a stakeholder pension for your child means tying the money up until they retire. At the moment this is a minimum age of 50, but the Government is considering increasing this to 55. What happens if disaster strikes and the money is needed for other uses before then? If it is a pension fund the money is not available -- of course, with the benefits of compounding, this may be a real benefit in disguise.

2. You have to buy an annuity, which will not give you as good a return as investing the fund, and of course will give you nothing to pass on to your relatives when you die.

3. We are looking a long way ahead. In 60 years a lot can happen, governments change, and regulations get altered. It may be that the rules are tightened to take away the opportunity for this in the future. If they are, what would happen to the contributions already made?

4. What if over the 60 years the tax relief on pension contributions was removed?

5. What happens if the "fund" that you choose does not perform very well over the full 60 years?

6. What happens if (when) the Government abolishes the child allowance, or more probably when it becomes means-tested?

The potential to put money away now, which will attract tax relief, to provide a pension for your child in 50 years' time, is an interesting idea. I am not sure that I will actually do it when it becomes available, however; what will you do? Have your say on the Investing for Children board and vote in the following poll.

Pensions for Children?

With the introduction of the stakeholder pension parents will have the opportunity to contribute towards a pension for their children, getting tax relief on the contributions even if the child does not pay tax. What will you do?

• I think it's a great idea; I will buy one for my child
• I think it is a loophole that will be plugged quickly
• I think it is too risky to tie up the money for 50 or 60 years
• I think my children should make their own way in life

Vote Here!

Where next?

Have your say on the Investing for Children discussion board
The Fool's Guide to Pensions
Thoughts on Annuities
Fool's Guide to Retirement Planning
Fool's Guide to Investing for Children