Three reasons to set up a pension for your child
“I’m setting up a pension for my baby,” a financial adviser told me last week. “I’m worried she’d use the money on something stupid when she reaches 18 if I started saving into a junior ISA.”
As a new(ish) mum, this struck a chord. While I’m concerned about my own retirement and how much money I’ll have managed to save, I’m even more worried for my one-and-half year old.
I’d never considered setting up a pension for my son. The accessibility of ISA cash always seemed more attractive – the money could pay for university fees, a new car, even a house deposit when he reached 18.
But according to HMRC figures, around 60,000 under-18s have a pension plan.
And there are a number of good reasons to set up a pension for your child.
The first and obvious advantage is access or lack of it. Under current rules, money in a pension is tied up until the age of 55.
That means you know your child isn’t going to splash out on a round-the-world trip with their savings the moment they hit adulthood.
The downside, however, is the age at which pension pots can be cashed in is being pushed back all the time. We already know you won’t be able to withdraw your private pension until 58 by 2028.
There are other political risks to pension saving. Governments seem to be consistently tinkering with the pension system. The current chancellor has given savers freedom to access their entire pension pot but has also significantly cut the amount we can save into a pension free of tax per year and over our lifetime.
However, legislation speculation is nothing new.
“The vast majority of the time, governments do put in place protections to safeguard assets accumulated prior to rule changes,” says Martin Jarvis of financial advice firm, Mattioli Woods.
The second big advantage is the generous tax relief on contributions your child will get even though they don’t earn an income.
Every child is eligible for a pension from the day they are born. It is taken out in the child’s name and anyone can contribute – parents, grandparents, other relatives – a maximum of £2,880 year and get 20% tax relief. So it is topped up by the government to £3,600.
You can contribute more than £2,880 but anything above that limit won’t benefit from a government top-up.
An added bonus for parents and grandparents is the £2,880 a year contribution is below the annual £3,000 gift allowance for inheritance tax and so would immediately fall outside the value of the donor’s estate.
The third advantage is the potential returns.
Given the long-term nature of a child’s pension investment, they will benefit from the magic of compounding, which is reinvesting the income they receive from their investments, thereby increasing the amount of money working for them over the longer term. In simple terms, it’s converting income into capital to earn more income and so on.
“Stock markets can be volatile but over the long term produce better returns and volatility doesn’t matter so much if you’re saving monthly or annual amounts,” says Andrew Pennie from Intelligent Pensions.
According to figures from Mattioli Woods, if the £3,600 maximum contribution is made every year up to the age of 18 and with a 4% growth rate, even if contributions are not maintained, the pot is worth around £100,000. By continuing contributions to the age of 55, the pot could be worth nearer £710,000.
When your child reaches 18 they take ownership of the pension and can keep adding contributions or leave the savings invested.
Setting up a pension
Several of the big insurance companies and pension providers offer basic, low-cost stakeholder pensions. Fees are capped at around 1% a year but these products have the least investment choice.
For people wanting to take a DIY approach, brokers such as Tilney Bestinvest and Hargreaves Lansdown offer junior SIPPs. These allow you to pick your investments – you can opt for shares, funds, investment trusts, ETFs, bonds or cash.
More on this topic: Top fund picks for my child’s pension