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FOOL SCHOOL
Pensions for Children?
Back in July 2000 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 Benefit."
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 this has changed. With stakeholder pensions, it is no longer be necessary to pay any tax in order to receive basic rate tax relief on money paid into these plans. Importantly there is 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.
One of the primary sources of funds for my own investments for my children is Child Benefit. Imagine what would happen if this money was invested into a stakeholder pension for the benefit of my children; currently it is £16.05 a week for the first child and £10.75 a week for any subsequent child. So, basing this on our first child, if we invest £16.05 a week, or a rounded-up figure of £835 a year, after grossing this to take advantage of the tax rebate of 22%, we would get an equivalent investment of £1,070 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 contributions until she retired at the age of 50; how much would it be worth? (For simplicity let's ignore the fact that the rate of benefit may change in the future.)
At the age of 18, assuming an 8% annual rate of growth and a 1% annual management fee, Catherine's fund would be worth about £29,450. If she stopped contributing and left this to continue growing at 8% a year less the 1% annual charge, then by the time she was 50 years old the fund would have grown to over £350,000. 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.
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. 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 50 years a lot can happen, governments change, and regulations -- particularly apparent "loopholes" like this one -- 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 50 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 50 years?
6. What happens if the Government abolishes Child Benefit or, more probably, if 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 interesting. I am not sure that I will actually do it when it becomes available; but it creates another opportunity, and it certainly adds to the choices you have!
In Conclusion
Investing money for your children for the long term in the stock market is one of the best presents that a parent can give to their offspring. Small contributions made for a child, left to compound, can build up into quite large funds; funds that can be used to give your child a head start, to help them fund the purchase of a house, help with the cost of going to university, or provide for their old age.
As we often point out at the Fool, the so-called "safest" investment vehicle -- putting your money in an interest-bearing bank account -- is in one sense the most guaranteed of them all to be a losing proposition. The "risky" investment in the stock market will, over the long term, usually prove to have had the lower risk.
Children born today in Britain can expect to live for 80 years or more, so start saving and investing for them when they are young. Teach them how to manage their own money, and help them benefit from the miracle of compounding!
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