Setting up a pension for your child will help set them up for a wealthier retirement, is very tax efficient and helps introduce them to the concept of long-term saving. So why don't more people do it?
When is a pension not just a boring pension? When it helps to introduce your child to the concept of long-term saving
There are many ways parents, grandparents, godparents and family friends can help secure a child’s financial future.
There’s a lump sum towards a house deposit, a savings account, a Junior Isa (Jisa) or even Premium Bonds.
Such gifts are incredibly useful, but some parents are adopting an even longer-term view. One they believe will encourage their youngsters to take more control of their finances into adulthood – that is, setting up a pension.
Up to £2,880 per year can be paid into the pension of someone under 18, and it is estimated that over 60,000 children now have one, according to figures from HMRC.
And some parents are starting early – Nathan Long, senior pensions analyst at Hargreaves Lansdown, says 7% of all pension accounts it sets up for children are for newborns.
The fact is that a pension remains one of the most tax-efficient vehicles available. Kate Smith, head of pensions at provider Aegon, explains that although children don’t pay tax, they still benefit from tax relief. “Once the money is paid in, the pension provider claims back £720 tax relief from the government. So that £2,880 is worth £3,600 once it’s in your child’s pension fund.”
Kay Ingram, director of public policy at independent financial advisory firm LEBC, says parents have long used pensions for kids to avoid a large inheritance tax (IHT) bill. This is because you can give away up to £3,000 a year without it being liable for IHT.
The major drawback of setting up a pension for a child is that the money cannot be accessed until they are approaching retirement. Currently, pensions can be accessed from age 55, but this age will go up as the state pension age changes.
Matthew Walne, director of Santorini Financial Planning, adds: “I would take a step back and ask why you would recommend a pension for someone who can’t take capital and income from it until at least 58, which could be even later depending upon state pension age increases. They are likely to have much greater needs for capital beforehand, such as a deposit for a house.”
‘I deeply regret not starting a pension until my 40s’
James (who wishes to remain anonymous), is a self-employed architect from London. The 58-year-old says he regrets not starting a pension sooner.
“I deeply regret not having started my own pension until I was in my 40s. Looking back, the main reason was because I had no idea how to and I didn’t have an independent financial adviser (IFA) to help me.
“I didn’t want my own children to make the same mistake, so on their 18th birthdays I made a one-off contribution into a pension plan.
“I figured that putting a plan in place, which they could add to later, was as valuable to them as the actual gift of the £500 paid in. The hassle of setting up a pension had been taken away from them.
“I could have just given them the money, but I thought cash was likely to be spent on fast cars or socialising, whereas the pension would give them greater long-term benefit.”
However, what makes a pension so inaccessible is also what makes it appealing, particularly if you have concerns about your child spending money that you’ve put away in a savings account.
Ms Ingram explains: “Savings accounts set up for children allow them to access the money when they reach 16 and spend it from the age of 18. With the best will in the world, 18-year-olds will not be able to deal with a large sum of money. The potential for it to be wasted is huge.”
She adds: “An 18-year-old will not have the same priorities as the parent or relative who for years has put that money aside.”
The role of pensions in financial education
Installing an appreciation of delayed gratification is only half the appeal, though. Alan Chan, a chartered financial planner at IFS Wealth and Pensions, says parents are using their child’s pension to help show the power of long-term investing.
He explains: “Using apps such as 7Imagine means children can actually see their investments rising and falling each year.
“By the time they are working and investing themselves, it will no longer be alien to them. Using an app also provides a great visual plan, in fact IFAs use a more detailed equivalent when modelling their clients’ finances.”
Faith Archer, a money blogger at Much More With Less (Muchmorewithless.co.uk), believes a pension is a great tool to help your child understand concepts such as compound interest.
She says: “Talking to your children about pensions is a brilliant introduction to compound interest, and something that can help them avoid debt disasters from credit cards, overdrafts and mortgages in later life. Showing just how big a small amount can grow, when invested for a long time, is mind-blowing.”
Scott Gallacher, a chartered financial planner, adds that if your child sees their investment fall and then rise it also helps with the concept of risk.
“In terms of educating children about the long-term power of investment it could potentially be huge if the child sees how much better their pension fund has performed versus a savings account. It always shows the risks of investment if the pension fund falls in value.”
Where to get your child’s pension
If you have an IFA already helping with your own pension, they should be your first starting point.
If cost and time is an issue, and you are sourcing it yourself, Ms Ingram and Ms Smith say it’s worth considering a stakeholder pension. Providers include Aviva, Legal & General (L&G) and Virgin Money. A stakeholder pension has its charges capped at 1%.
A more expensive, and higher-maintenance, option is a Junior Sipp (self-invested personal pension). You can invest directly into shares and investment funds through providers such as AJ Bell, Interactive Investor (Moneywise’s parent company) and Hargreaves Lansdown.
Ms Smith says: “The trick is to make sure you invest in growth stocks and shares with a low charge. You can afford to take risks because your child is investing over several decades.”
Whatever option you choose, making regular payments (even if it’s once a year) means your child’s investment will benefit from pound cost averaging. This is because drip-feeding money into an investment reduces the risk of a stock market fall wiping out a large lump sum and smooths returns over time. So when the stock market falls and share prices come down, for example, your contribution will enable you to buy more shares at a lower price, priming you for bigger returns when markets bounce back.
The writer’s story: ‘I’ve set up a pension for my child’
Samantha Downes (pictured above), the writer of this feature, says: “I’m a 47-year-old freelance financial journalist from Stansted, Essex. I have two daughters, aged nine and five. My oldest daughter, Imogen, was lucky enough to get £250 from the government to put into a savings account, a child trust fund (CTF).
“My youngest, Isabella (pictured above, third from left), didn’t get the £250, but instead I set up a Junior Isa (Jisa) for her when she was six months old.
“Last autumn, when Isabella started school full time, I went freelance and had to take stock of all my finances, including the amount I was putting aside for my children. Having older nieces who are about to access their own savings accounts has made me wary of putting more lump sums into the children’s CTF and Jisa.
“So I set up a Junior Sipp for Imogen. The idea is that as the money grows, or doesn’t, we can explain to Imogen why and how.
“I want to empower her to manage her finances – it’s a life skill she needs to learn. I wish I had done this a couple of years ago. When my youngest turns seven we will do the same for her.”