Following the demise of the child trust fund, why not look to an underrated alternative to save for your child's future, asks Esther Armstrong.
Now the child trust fund is on its last legs, alternative methods of saving for children will get more of a look in. Children’s individual savings accounts and saving accounts for children speak for themselves, but have you ever considered setting up a pension for your little ones?
This could be more beneficial for their future compared to other products when you consider the meagre state pension and a general inertia towards pension saving in the UK. And there's the added benefit that they can't get their grubby paws on it until they are 55. Here we sum up the main issues you should think about before opening a pension for a child.
1. Whose name is the pension in?
The pension will be under the designation of a third-party contributor, but in the child’s name from day one. On the child’s 18th birthday the pension will no longer come under the designation of the third party and the child can begin to contribute to it in his or her own right. The third party can still continue to contribute to the pension fund.
2. Who can contribute to a child’s pension?
Following the Stakeholder Pension
Legislation Act in 2001, third parties, irrespective of age or earnings, can contribute £3,600 gross to another person’s stakeholder pension each tax year. Any third party can invest in a child’s pension, be it parents, godparents or friends.
With basic-rate tax relief taken into account, the maximum contribution works out at £2,880. Colin Jelley, head of tax and financial planning at Skandia, says a net total of under £3,000 is significant from an inheritance tax
(IHT) perspective: “Each year, individuals can give gifts from their taxed income of up to £3,000 [provided it doesn’t affect their standard of living] without attracting IHT liability.”
3. What are the options?
There are no specific children’s pension products because the market is still relatively underdeveloped. But traditional pension products do the job well enough. In choosing the best product, Mike Morrison, head of pensions development at Axa Winterthur, says: “It really depends on what you are trying to achieve and also on the cost – since you are only paying £3,600 gross each year, you don’t want something heavy on charges.”
For this reason, stakeholder pensions are the favoured option. They are also suitable because of the long-term nature of children’s pension investment. Provided the stakeholder has a decent variety of funds, you can leave it alone for years at a time. As the fund gets bigger you may want to consider looking at more sophisticated options, such as transferring to a self-invested personal pension, for example.
Fund choice and charging structure are the most important considerations when making your choice.
4. Why is a pension better than the CTF was?
CTFs had a maximum contribution of £1,200 per year, compared with a maximum of £3,600 into a child’s pension. Jelley says if the maximum was contributed over a period of 18 years then the fund the child inherits could be worth £1 million, assuming the child takes benefits at the minimum retirement age of 55. This is based on the standard FSA
growth rate for pensions of 7% and assumes average investment returns.
Tax relief on pensions has become less generous in recent years and could be tweaked further in the emergency Budget. Yet even at the current basic rate there’s still a 20% gain to be had. Any gains within the fund are sheltered from capital gains tax
and income tax. Another benefit is that unlike the CTF the investment cannot be accessed until the individual reaches retirement age.
5. How common is it to start a pension for kids?
Morrison doubts there are that many children’s pensions. However, Carl Lamb, managing director at financial advisers Almary Green, says that for those who have the additional cash there is probably no greater gift for their child. “The way the UK pensions industry is going, by building a strong basis for your child or grandchild you will give them a solid foundation for when they start their own pension saving.”
A form of money purchase defined contribution pension launched by the then Labour government in April 2001 with low charges and no-frills minimum standards. Designed to appeal to people on low and middle incomes who wanted to save for retirement but for whom existing pension arrangements were either too expensive or unsuitable, the stakeholder didn’t really take off and looks to be superceded by the National Employee Savings Trust (NEST).
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.
The Financial Services Authority is an independent non-governmental body, given a wide range of rule-making, investigatory and enforcement powers in order to meet its four statutory objectives: market confidence (maintaining confidence in the UK financial system), financial stability, consumer protection and the reduction of financial crime. The FSA receives no government funding and is funded entirely by the firms it regulates, but is accountable to the Treasury and, ultimately, parliament.
Capital gains tax
If you buy an asset – shares, a second home, arts and antiques – and then sell it at a later date and make a profit, that profit could be subject to CGT. You don’t pay CGT on selling your main home (which is why MPs “flipped” theirs so regularly) or any securities sheltered in an ISA. Individuals get an annual CGT allowance (£10,600 in 2010/2011) but if you have substantial assets it’s worth paying an accountant to sort it for you.