Start a pension for your child

Published by Faith Glasgow on 14 May 2013.
Last updated on 29 May 2013

Starting a pension for your child seems one of the wackier ideas to come out of the personal finance arena. Why would a parent or grandparent contribute to a savings scheme so long term it won't be accessible until the child turns 55 at the earliest?After all, kids will face so many demands on their money in the first part of their lives – university fees, unpaid internships, a foot on the housing ladder – that surely any savings provision you can make for them should be focused on helping them through that period?

Well, yes – and that is where setting up a tax-efficient junior ISA (JISA) can make a lot of sense. Each year, up to £3,720 (for the 2013/14 tax year) can be tucked away safely in a tax-free account, with no access for parents or child and when the child reaches 18, their nest egg is ready to help them weather the financial storms ahead.
Or that's the hope, anyway. In practice, says Adrian Boulding, pensions strategy director at Legal & General (L&G), some parents worry their child will find other, less responsible uses for it. "There's a good reason why child trust funds, the predecessors of the JISA, were dubbed 'motorbike funds'," he comments.
The risk of irresponsibility is not an issue with a children's pension, because the child cannot access it until the age of 55. But it could transform your child's longer-term financial future in an eye-opening way.
There are several attractions. Money put into a child's pension gets the same tax relief as any other pension. So even though your child is not a taxpayer, the taxman will add 20% to payments, to a maximum £3,600 each tax year (£2,880 of relatives' contributions and £720 in tax relief).
Additionally, when the child comes to draw on the pension, they can take 25% as a tax-free lump sum.
Junior ISAs versus children's pensions
Annual contribution (max) £3,720 (rising) £3,600
Monthly minimums £1 cash/£10 shares Typically £30 to £50
Tax treatment Contributions out of taxed income; tax-free returns within the JISA and tax-free on withdrawal Child gets extra 20% tax relief on contributions; tax- free returns within pension; pension income taxable; 25% tax-free lump sum
Investment options Cash or funds investing in stocks and shares Funds investing in stocks and shares. Greater choice with SIPPs than low-cost stakeholders
Child access to fund 18 55
Parental access to fund? No No
Useful for? University, house deposit Retirement income

Massive growth potential

If you're saving for retirement from birth, that money has a massive 40 or 50 years of undisturbed growth ahead of it. Say, for example, you set up a child's self-invested personal pension (SIPP) when baby Chloe is born and a set of grandparents agrees to pay £30 a month into it.
With 20% tax relief, their contribution is boosted to £36 a month. You choose a provider and select a reliable investment that produces returns averaging around 5.5% a year (after charges of 1.5% a year).
By the time Chloe reaches 18, the grandparents have drip-fed £6,480 into the pension fund; thanks to compounded growth, it's worth around £13,200. At that point, the pension passes into Chloe's control. Even if no further contributions are made, continuing investment growth will mean that by the time she reaches the age of 65 it's worth £175,000 (without taking into account the erosive effect of inflation).
If Chloe continued to invest into her pension fund, bumping her contributions up to £50 a month and holding them at that level from 18 until 65, her fund would be worth £324,000 in today's money.
Even allowing for inflation at 2.6%, her retirement fund would be worth over £97,000 in real purchasing power. Without the grandparents' relatively modest £30-a-month contributions, Chloe's pension fund would be less than half its value, at around £160,000 (before inflation).
However, Boulding believes an even more important benefit of setting up a child's pension is that it means children are familiar with pensions from the start of their working life. "The biggest attraction is that a pension gets them started with a savings habit; they take control of it from the age of 18, at which point they can transfer it into an occupational pension or keep it separate," he says.
"Under the new auto-enrolment rules, young workers have a right to a workplace pension with an employer's contribution, but until the age of 22 they're not automatically enrolled. If they have already been following the investment performance of their pension, they are more likely to ask to be enrolled."
At the same time, says Alistair Hardie, head of customer consolidation at Standard Life, a child's pension also gives them the flexibility to make smaller pension contributions if need be. "Having their own pension growing means they can focus on other financial priorities during their working life," he explains.

What are the choices?

The cheapest option is a low-cost stakeholder plan available from the likes of Standard Life, L&G or Aviva, giving access to a limited range of funds. If you want a wider choice of assets and funds, consider a children's SIPP from providers such as Alliance Trust Savings or
Hargreaves Lansdown.
Given the timescale, says Tom McPhail, head of pensions research at Hargreaves Lansdown, parents be more adventurous: "Investing over a long timespan not only gives compound interest time to work its magic but also makes it easier to take on investment risk, which is ultimately likely to deliver more generous returns."
Of course, the limitation of a pension is people cannot use it when they may really need it in their youth.
"If you can afford to contribute to both a JISA and a children's pension, it really makes sense to run them in parallel – that way you're helping with 'near money' for the imminent costs they'll face, but also with 'far money' for retirement," explains Hardie. "Especially given increasing life expectancy, kick-starting their pension is a great legacy for a child."

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Law needs changing, many many

Law needs changing, many many grandparents don't trust their children to honour the money that's given to grandchildren, so not allowing grandparents to set up a pension for grandchildren in their own right is wrong and needs to change