Junior Pensions
You may not know that you can start junior pensions for children (anyone aged under 18). This can be an exceptionally good way to save for your child’s future, as it means pension benefits can build up over their own lifetime (rather than just from when they start work).
Starting a SIPP for a child under 18
You can open a self-invested personal pension (SIPP) for anyone under 18. You can pay a maximum of £2,880 per year into this, which becomes £3,600 through 20 per cent tax relief.
Why is it such good value at this age?
By starting early, you are making full use of the investor’s best friend: compound interest. Here’s an example.
Sally opens a junior SIPP for her baby Rose soon after she is born. She contributes the annual maximum of £2,880, which becomes £3,600 a year, and stops paying into it as soon as Rose turns 18. Assuming no further payments by anyone, and a steady 4 per cent growth, then by the time Rose is 65 the pension pot will be over £620,000. However, Sally paid in only £51,840 – so the total growth is nearly 1,200 per cent.
How does this compare with an ordinary pension?
Let’s suppose Sally doesn’t do this, and leaves Rose to start her own pension at the age of 25. How does it compare?
Assume that Rose pays in the same amount each year (for comparison’s sake, we won’t factor in employer contributions). She pays in £240 a month, which tax relief tops up to £300 (making £3,600 a year) until she is 65. She has contribute for 40 years and paid in a total of £115,200. But what is her final pension pot?
The final sum works out at just under £356,000. This is £264,000 less than what she would have built up in a Junior SIPP – yet it has cost her more than twice as much. The total growth on her contributions this time is just 300 per cent. It’s still a lot – but only a quarter of what the junior SIPP delivered.
Why start a pension for your child?
You may still hesitate to do this – you’re unlikely to be around when your child starts drawing their pension, and you’d rather help them financially when they’re younger. But in effect, you would be. If your children know that they have a decent pension plan in place already, they should have more spending power for other things. So by paying into a SIPP while your child is growing up, you could be indirectly helping them to buy their first property (for instance).
Another off-putting factor may be the extra expense – few new parents can afford to pay out an extra £240 a month. But even if you only pay in a little, compound interest can still result in a sizeable pension pot by the end. Just £10 a month from age 0 to 18 can result in a pension pot of over £20,000 by age 65 (around 900 per cent growth).
The inheritance tax benefit
There is another advantage to setting up this kind of pension for a child (or indeed grandchild). Anyone looking to pass on assets to their family should think about HMRC’s inheritance tax. You can of course give lifetime gifts to reduce the value of your estate, but anything over £3,000 in a year will be taxed if you die within seven years of making it.
A gift under £3,000 may not seem very much – but as a pension contribution it’s another matter. If you pay into your grandchild’s SIPP, for example, you could pay the annual maximum of £2,880 and stay comfortably within the tax-free gift limits, while your gift would become £3,600 through tax relief.
This creates a wonderful nest egg for the child’s future, while at the same time reducing the size of your taxable estate (so you can pass on more to your own children).