Pensions provide us with a financial safety net in retirement. Common advice is to start saving for a pension early so as to make full use of compound interest. But did you know that you can also save for and secure your children’s future through a pension?
In this article, we’ll explore why you might consider setting up a pension for your children.
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Why save for your children through a pension?
A child’s pension, also known as a junior SIPP (self-invested personal pension), is a tax-efficient way to save for your children’s retirement.
Parents can open one for a child under the age of 18. The child automatically gains control of the pension once they reach 18. They can then decide where the money is held and invested.
A child’s pension enjoys similar tax reliefs to an adult pension.
It allows you to save up to £2,880 per year which receives a 20% tax break from the government. This essentially means a 25% increase in your contribution, bringing the total to a maximum of £3,600 per year.
The longer your funds stay in the scheme, the more time they have to grow. So, it’s useful to begin early.
As Tony Clark, senior propositions manager at St James’s Place Wealth Management says: “The benefits of a long-term approach to investing are time-tested and the principle is very simple: the longer an investment has to potentially grow, the greater the benefit will be from the year-on-year compound effect of reinvested returns.”
According to an example from financial comparison website Unbiased.com, if you invest the maximum amount of £2,880 into a child’s pension each year, from birth to the of age 18, the pension could be worth £95,000 by the child’s 18th birthday (assuming a growth of 4%).
Even if no additional contributions are made to the pension pot, a steady interest rate of 4% could grow it to over £620,000 by the time the child is 65.
Of course, due to inflation, that sum may not be worth what it is now. Remember also that these figures are based on today’s tax rules which could change in future.
Regardless, the sum is substantial enough to make a significant difference in your children’s future.
What are the benefits of saving for your children through a pension?
There are several benefits to establishing a pension for your children. Tony Clark explains: “Just as with pensions for adults, pension pots for kids have the opportunity to grow in a tax-advantaged environment.
“In common with junior ISAs, anyone can pay into the pension on the child’s behalf – parents, grandparents, godparents, friends or other family members. (Bear in mind that only the child’s parents or guardians can set them up initially.)
“The benefits of saving for a pension for a child can be felt long before they even gain access to it. It can alleviate the pressure on the child when they are first starting out their careers and facing the costs of starting a family and buying their first home. It may help to boost their understanding of tax relief and the value of saving.
“Saving this way may also help mitigate an Inheritance Tax (IHT) liability.
“Perhaps the most compelling reason, though, is that starting early and saving regularly can have an extraordinary impact due to compound interest.”
While the fact that your children won’t access the funds for decades may appear to be a disadvantage, it can actually be a benefit.
It means you won’t have to worry about your children blowing the money you’ve been saving for them as soon as they turn 18. This could easily be the case if you were to save through a junior ISA. Money in a pension can only be used for retirement.
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Where can I set up a child’s pension?
There are many investment platforms in the UK currently offering junior SIPPs.
Some offer ready-made portfolios for junior SIPPs, whereas others allow you to choose your investments. You can, for example, opt for cash, investment trusts, ETFs, unit trusts, individual stocks and shares or bonds.
Hargreaves Lansdown, AJ Bell, and Fidelity are among the current platforms that offer junior SIPPS.
It’s a good idea to shop around and compare the costs of all the junior SIPPs on offer. This will increase your chances of getting the best possible deal. Even small differences in fees or charges add up over time, reducing the overall value of your children’s retirement pot.