When it comes to building a nest egg for later life, early starters have a distinct advantage.
Thanks to the miracle of compounding, which can be compared with how a snowball gathers more and more snow rolling down a hill, becoming bigger and bigger as it goes, their early savings contributions become significant over time.
People in their twenties are often advised to start a pension as early as possible to take advantage of the compound effect from as early as possible, but there is a way to save for retirement even earlier, and that is for parents to set up a pension for their children.
Pensions for babies
As well as compounding there is one other big advantage to setting up a child’s pension: free money from the Government. Even though most children do not earn money and pay tax, the government will add tax relief to a pension for an under 18-year-old, helping their pension pot to grow.
Parents can pay up to £3,600 gross into a child’s pension account each year, or £300 a month. £240 of this is the parent’s money, and £60 is Government tax relief. If a parent kept up this level of payment from birth until a child was 18, and the pension grew at five per cent a year, this would be worth £329,000 by the time the child is 60 without the child adding a single penny (these calculations assume an annual administration charge of 1.25 per cent).
The one big drawback
These are impressive figures, but there is one big drawback to a pension for a child, and that is that they cannot access it until they are far older. At present, a Self Invested Personal Pension (SIPP) cannot be accessed until the age of 55, but we already know this will rise to 57 in 2028, and it is likely to rise further.
Many children may need a sum of money before this stage, for example as a deposit for a or to pay for university fees.
Making it count
The pros and cons of a child’s pension need to be weighed up carefully before a decision is made. On the one hand, starting a pension for your baby means that, when they are 18, they have already made a start on retirement savings and will face less pressure when planning for later life, but on the other they may appreciate a financial gift more when they are younger.
There are other tax efficient savings accounts available for children, including the Junior ISA (JISA) where the money can be accessed by the child once he or she turns 18. Although the JISA does not include the tax relief bonus of a junior pension, the money in it can still grow tax free, and there is no tax to pay when it is withdrawn, unlike with a pension.
There are also some trust structures, which can help families to save tax efficiently for children and grandchildren, but these will require input from specialist solicitors.
Getting the balance right
Free top-up money from the government is a good incentive for parents, and a ready-made pension pot for an 18-year-old is a great way to get them started in the habit of saving for their own retirement, but a pension for a child can only be a part of a sensible strategy for providing for your family in the future.
Ensuring that there is money available from the ‘bank of mum and dad’ for other major financial expenditures along the way is also important, while families need to ensure that they also consider the impact of sudden shocks upon family finances, and are appropriately insured against critical illness and other adverse life events.