Save for your child's pension
Locking up savings for at least 55 years in a pension plan sounds like a cruel trick to play on the younger generation - who probably could do with some cash sooner rather than later. But you may well find they will thank you - or at least your memory - profusely, come the day they retire.
Pension rules mean anyone can have a pension and receive top-ups on contributions from the government, whether they work or not - and that includes children.
David Downie, technical expert at Standard Life, explains: "A parent or guardian can set up the pension but grandparents can contribute thereafter if they want. The maximum you can invest is £2,880 every tax year. Then the government will add basic-rate tax relief to that, which is equal to a gross investment of £3,600 once the tax relief is added. Imagine if someone had saved like that for you when you were a child."
If you started investing £240 a month into a pension for a child born this tax year, for the next 18 years, equal to the maximum annual amount of £2,880 a year, this will grow tax-free and after 18 years your contributions would total £51,840 - plus there is the added contribution from the government. This would mean £64,800 paid into the pension in total.
According to Standard Life's sums, this could provide a pension income of £26,000 a year at age 65. These figures assume a 5% a year growth rate and an annual investment charge of 1%, but do not take into account the inevitable impact of inflation.
If you invested the same amount each month for a child who is 10 this tax year until they are 18, then when they reach 65 it could provide an annual income of £21,000. However, either way, they can start to access these savings from age 55, including being able to take a tax-free lump sum of up to 25%, under current rules.
Downie adds: "Not only are you helping your child with their future by saving into their pension, there are other benefits, too. As well as being a tax-efficient way to save, payments into a child pension will be regarded as gifts. As such, it's possible that they may not be subject to inheritance tax (IHT), which is an added benefit.
"Your annual IHT exemption for gifts is £3,000, so that means you can invest the full £2,880 each year and it is immediately outside your estate for IHT. Over the 18 years, it could mean that you have saved up to £20,736 in IHT. That's because there's £51,840 less in the estate, which will not have IHT paid on it at 40%."
Tax-free lump sum
An inelegant phrase that is nonetheless accurate in what it describes: a one-off payment to a beneficiary that is free of any form of taxation. Usually received when using a pension fund to purchase an annuity, as 25% of the overall fund can be taken as a tax-free lump sum.
The tax levied on the total value of your estate after you die. IHT has to be paid by the beneficiaries of your estate before they can receive any of the money from it. The money can’t be taken from the value of the estate _– it has to be paid before any money can be released. There is an IHT threshold – known as the “nil-rate band” – below which no tax is levied (£325,000 in 2011/12). Any amount above the nil-rate band is subject to tax at 40%. If your estate totals £600,000, there is no tax on the first £325,000; however your estate will pay 40% tax on the remaining £275,000, a total of £110,000. Prudent tax planning can reduce your IHT liability, so always consult a specialist solicitor.
An increase in the general level of prices that persists over a period of time. The inflation rate is a measure of the average change over a period, usually 12 months. If inflation is up 4%, this means the price of products and services is 4% higher than a year earlier, requiring we spend and extra 4% to buy the same things we bought 12 months ago and that any savings and investments must generate 4% (after any taxes) to keep pace with inflation. Since 2003, the Bank of England has used the consumer prices index (CPI) as its official measure of inflation (see also retail prices index).
Everything you own: all your assets (property, cars, investments, savings, insurance payouts, artwork, furniture etc) minus any liabilities (debts, current bills, payments still owed on assets like cars and houses, credit card balances and other outstanding loans). When you’re alive this is called your wealth; when you’re dead, it becomes your estate.