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Forget the toys: how a gift of £100 a year could net your child £27k

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Written by: Paloma Kubiak
20/12/2016
Instead of buying your child a toy at Christmas, could £100 a year be better spent invested in a pension, Junior ISA, savings account or a trust? We crunch the numbers.

We’re not saying you need to be a scrooge, but if your child’s toys are already stacking up and you want to help them in the future whether it’s for university fees or a house deposit, could your money be better spent elsewhere?

We look at the numbers based on a £100 a year deposit over 18 years, and longer when it comes to a child’s pension:

Pension

Every child is eligible for a pension from the day they’re born and around 60,000 under 18s have a scheme.

Anyone can contribute a maximum of £2,880 a year and the pension gets 20% tax relief on top, bringing the annual amount to £3,600.

Pension money is tied up until the age of 55. This means your child can’t get their hands on the cash and spend it frivolously. However, the downside is the age you can cash in your pension keeps getting pushed back – we already know from 2028, you’ll have to be 57 – so who knows how old your child will be by the time they can access their money?

However, another plus point is pension money benefits from compounding and tax relief on contributions even though your child does not earn a salary.

If £100 is contributed each year and the government tax relief is added – so £125 is invested each year over 18 years and assuming a 4% investment return – this would generate a pension pot of around £3,300, according to Martin Jarvis of financial advice firm, Mattioli Woods.

If you increase the amount to the maximum annual amount over an 18-year period (£3,600 including government top-up), with a 4% growth rate, the pension pot would be worth closer to £100,000 or nearer £710,000 if contributions are continued to the age of 55.

If £100 a year is invested from birth to the age of 57, over the course of this time, the pot would yield a fund value of around £27,000.

With these types of scheme, they revert to the child’s ownership from age 18 but if you want to continue contributing past this age, Jarvis said the contributions are treated as if the child has made them. Once the child begins earning, the maximum tax relievable contributions they can make are the higher of £3,600 per year or their earnings (up to the annual £40,000 allowance or ‘carry forward’ rules).

See YourMoney.com’s Three reasons to set up a pension for your child for more information and to find out how to set up a scheme for your little one.

Junior ISAs

These are a type of children’s savings account providing a long-term, tax-free scheme to replace the old Child Trust Fund.

Parents or guardians can open a JISA for a child under 16, but anyone can pay money into them as long as it doesn’t exceed £4,080 for the current 2016/17 tax year. The child can only access the money when they turn 18 but they can take control of it when they’re 16.

JISAs come in two forms: cash, and stocks and shares. The current best buy is from Coventry Building Society, paying 3.25% AER (variable). The next best are from Nationwide, Halifax, TSB, Tesco Bank and Darlington Building Society which all pay 3% AER (variable).

Based on an 18-year time scale with a parent paying in £100 a year and a 3% interest rate, you would be able to give your child £2,411.69 on their 18th birthday, according to Savings Champion.

If you were able to put away £100 a month for 18 years, you’d be able to give them £23,400 without any interest applied.

If you wanted to max out the JISA allowance, planning is a little more tricky as we don’t know what future allowances will be – however if we assumed £4,080 (the current allowance) was saved for every year for 18 years that would amass £73,440 without interest.

Rachel Springall, finance expert at Moneyfacts, said: “Most of the best buy JISAs from the well-known brands pay 3%, which is significantly higher than most adult savings accounts, although the rates on the best JISAs are variable and can change at any moment.”

An alternative is a stocks and shares JISA. These are higher risk as you are investing in the stockmarket, but returns could be extremely attractive over the long-term.

With stocks and shares ISAs, it’s a little more tricky to estimate what the total amount could be after 18 years, but contributing £78.46 a week to a junior ISA, in other words maximising your child’s JISA allowance (£4,080 for 2015/16), could provide them with £106,208 when they reach 18, based on 5% growth per year, according to Fidelity International.

See YourMoney.com’s Junior ISAs turn five: how to make the most money for your kids for more information, plus fund picks.

Children’s savings account

The good news is that you don’t usually pay tax on children’s savings accounts; the bad news is that like adult savings accounts, children’s savings accounts have seen a raft of interest rate cuts since the Bank of England cut rates from 0.5% to 0.25%.

However, there are still competitive child savings accounts offering access in branch, by post or online:

ymoney-childrenssavings

According to Savings Champion, £100 paid in each year over an 18-year period (£1,800 deposited) would leave you with £2,411.69 by the time your child legally becomes an adult.

Trust

With a trust, it’s the person who sets it up who can set out the terms of when and how the money can be used by beneficiaries.

Whether a trust is right for you depends on your end goals. If you want a child to have the money when they reach 18, a trust could work out to be complex and expensive compared to a JISA, according to Jarvis. If you wish to retain control or need the income in the near future, a trust could be the best option.

There’s no limit on the amount that can be placed into trust, though you should consider the effect of the inheritance tax nil rate band which is currently £325,000 .

Jarvis said it’s important to speak to legal, tax and financial planning experts to ensure the most effective and straightforward solution is presented for your circumstances.

See YourMoney.com’s Should I set up a trust for my children? for more information on the different type of trusts and how you can set one up for your kids.

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