Children’s pensions: watch their money grow

The pot that keeps on giving

The notion of a children’s pension might appear odd at first, given that it’s many decades away with all sorts of life events still to come. However, setting up a pension for your child means the sooner you can start them on their saving journey, the longer the money has to grow.

Pensions are a tax-efficient way to save, and having a pension pot from a young age means that even small contributions will go towards your child’s future financial well-being, with – hopefully – a tidy nest egg for them to benefit from one day.

That invaluable pension pot will see your child not only be in a position to look forward to a comfortable retirement, but it will also enable them to focus on meeting their financial goals during adulthood. What’s more, given the current life expectancy prognosis – one in five girls and one in seven boys born in 2020 are expected to live to 100¹ – the impact of planning today for your children’s future cannot be underestimated.

When can you set up a children’s pension?

There’s no minimum age when it comes to starting a children’s pension – a child can have a pension from birth. While it must be set up by a parent or legal guardian, anyone can then contribute, from parents themselves to grandparents, godparents, friends or other relatives.

Just as with an adult’s pension, contributions are given a 20% boost by the government – even if your child is yet to be a taxpayer. Not only that: if the time comes and your child becomes a higher or additional-rate taxpayer, further relief can be claimed on future contributions via self-assessment – something you won’t get from an ISA, which is another tax-efficient saving tool.

Furthermore, any growth generated by the pension won’t be liable for Income Tax or Capital Gains Tax.

The parent or legal guardian will look after their child’s pension until they reach the age of 18. From then on, the child will have control; however, they won’t have access to their pension until they reach 55 (rising to age 57 in 2028).

How much can you pay in?

The main difference between an adult’s pension and a child’s pension is the annual amount that can be contributed.

Up to £2,880 can be paid into a child’s pension for the 2023/24 tax year. Coupled with the 20% in tax relief from the government, this comes to £3,600.

Did you know that saving into a child’s pension can be advantageous in that it may also help mitigate an Inheritance Tax (IHT) liability? This is because payments may be covered by the annual £3,000 IHT gifting allowance or the exemption for payments made out of income.

Granted, the annual contribution limit for children is much lower than that for adults. Yet the beauty of compounding means that even small contributions can add up over time.

How does compounding work?

Tony Clark, Senior Propositions Manager at St. James’s Place says:

“Starting early, and saving regularly, can have an extraordinary impact. It’s all about compound interest – the key to growing wealth. Albert Einstein called compound interest the eighth wonder of the world and said: ‘Those who understand it, earn it; those who don’t, pay it.’ The secret is to start saving into a pension as early as possible, even with relatively small amounts, to take advantage of it.”

Fundamentally, compounding is growth on top of growth. In other words, the money generated by your investments is reinvested and is therefore capable of generating its own growth. The longer an investment has to potentially grow, the greater the benefit will be from the compound effect of those reinvested returns.

It’s a given that children have time on their side, so you may look to take on more risk with their pension investments. For instance, it’s quite common for younger investors to be fully invested into equity funds.

How will your child benefit from a pension?

There is a multitude of pressures for young people on entering adulthood, and saving into a pension can go some way to easing these. Your children can then focus their attention on events other than retirement planning when they are building their careers and potentially facing the costs of buying their first home and starting a family. It makes sense that growing a pension sooner rather than later may help to boost their understanding of tax relief and the value of saving.

“Educating the next generation in financial literacy is not a nice to have – it’s the best investment you can make to secure their financial future,” says Tony.

As with all other habits, young children learn their money-saving habits very early in life, yet rarely with lessons on budgeting and money management to complement this. Supporting your child to fund their own pension might just be a way of helping them get to grips with concepts such as compound interest.

How else can you save for a child’s future?

Aside from setting up and contributing to a child’s pension, a Junior ISA (JISA) is a popular choice when it comes to saving for their future.

A parent or legal guardian can open a JISA, and anyone can subsequently contribute up to the point when the child turns 18. Just as with other ISAs, any returns will not be liable to Income Tax or Capital Gains Tax. Many people choose to take advantage of gifting money to children as they’re effectively removing money from their own estate – thereby helping to mitigate IHT or reducing the amount payable on death.

As of the 2023/24 tax year, you can pay £9,000 per child into a JISA each year – either stocks and shares, cash or a mix of the two. Bear in mind that the tax benefit of ISAs is one that you have to ‘use or lose’ – in other words, it can’t be rolled over into the next year.

The value of seeking financial advice is such that it will help get the ball rolling in terms of meeting your future plans – meaning you can pay for your children’s needs now while saving for their future.

Here at Wellesley, we go one step further by checking your own financial position first. Ahead of setting up a child’s pension, it’s important that you have a savings safety net and protection, and are putting enough away for your own retirement.

To discuss how best to invest for your children’s future and grow their money, get in touch with the Wellesley team on 01444 847825.

The value of an investment with St. James’s Place will be directly linked to the performance of the funds selected and may fall as well as rise. You may get back less than the amount invested.

The levels and bases of taxation, and reliefs from taxation, can change at any time and are generally dependent on individual circumstances.

Source:

¹ Past and Projected Period and Cohort Life Tables: 2020-based, UK, 1981 to 2070, Office for National Statistics, January 2022.