What are your priorities when saving for your child’s future? Perhaps you want to help them with university tuition fees or buying their first home when they hit 18.
But how about giving them the start of a pension fund? The earlier you start saving into a pension, the more it’s worth when you retire – so for maximum worth, start saving from birth.
If your own pension pot isn’t exactly the largest, it might sound odd to start saving towards the retirement of a newborn baby, but it’s worth considering.
The uncomfortable truth is that by the time your child reaches retirement age, you are unlikely to be around to help them financially – and even if you are still alive, you’re likely to be of an age where funding your own retirement is the priority.
So by investing wisely from day one, you can put together a retirement nest egg that will give your little one a more comfortable lifestyle when they reach day 25,000.
The rules on pensions for children
You might be surprised to learn that there are tax-free allowances for pensions for children and even government contributions to top up what you save.
The government will match 25% of your deposits, up to an annual total of £3,600 including the government’s contribution.
Reverse engineer the maths and that’s up to £2,880 you can pay in. You can deposit more if you want to, but the government’s contribution (paid as tax relief on your deposits) is capped at £720.
Break it down further and to hit the full £2,880 at the end of the year, you need to deposit £240 a month or about £60 a week.
Keep it up over 18 years and by the time your child reaches adulthood, their pension pot will already be worth £51,840 in direct deposits, plus a further £12,960 from the government tax relief.
Of course, your child won’t retire at 18, so the nearly £65,000 in their pension would continue to accrue interest over the years of their adult life.
Assuming steady growth at around 4% per year, your child’s retirement savings would pass £100,000 by their 30th birthday, £150,000 by their 40th birthday, and be worth nearly a quarter of a million by the time they reach 50.
If the retirement age increases to about 70 during your child’s working life, their retirement fund will be worth nearly half a million pounds by the time they access it.
An added bonus of investing in a pension for your child is that it gives your savings the longest amount of time to overcome any economic shocks so that, with luck, the kind of growth mentioned above should be achievable even if there is a recession in your child’s lifetime.
Let’s assume you don’t want to lock all of your deposits away in a pension scheme that your child cannot access until they retire.
Instead, you might want to split those savings so that some are in a pension, while others are accessible for those other priorities like paying for tuition or getting on to the housing ladder.
Even if you only put £10 a week into a pension, for a total of £40 a month plus the government’s tax relief contribution of £10 a month on top, and again assuming a compound annual growth rate of 4%, you give your child about £100,000 extra if they retire in their mid-60s.
Grandparents can contribute too. The £2,880 threshold for tax relief applies to all savings made on behalf of the child – but if the parents are saving less than that amount, the grandparents’ deposits could make use of any remaining tax relief entitlement each year.
Reasons to save over the long term
As mentioned above, paying into pension funds early in life maximises compound interest gains and increases the pot’s ability to weather economic shocks.
But if you want to make even greater gains, you could take advantage of that by choosing riskier investments, in the knowledge that if anything goes wrong, your child’s pension has longer to regain its value.
You might also appreciate that the funds are locked away until your child reaches the appropriate retirement age.
That way they don’t suddenly gain access to a £50,000 lump sum on their 18th birthday, just before they go away to Freshers’ Week and the temptation to spend heavily when living independently for the first time.
Just recognise that you’re unlikely to be around to enjoy seeing your little one enjoy the quality of life their retirement fund brings them – but you will have done everything you can to ensure they are comfortable in their own twilight years.
Alternatives to child pensions
If retirement seems too far off to lock tens of thousands of pounds away for your child, you might want to consider a junior ISA instead.
Like adult ISAs, JISAs have a maximum tax-free allowance each year, which usually rises in line with inflation.
You can save into a cash JISA or a stocks and shares JISA, again just like the adult equivalent, but anything you pay in cannot be withdrawn until the child reaches the age of 18.
This is a sensible compromise if you want them to have access to the funds from the start of their adult life, and are confident that you can raise them to be sensible about spending or saving it when it becomes their own responsibility.
Deposit £100 a month for 18 years, and assuming interest rates of about 4%, and your child will have nearly £35,000 to spend.
Try to resist automatically allocating that money to tuition fees – assuming they are still similar to today’s levels in another 18 years’ time.
Often tuition fees are better paid using student loans, which can represent excellent value for money compared with other forms of lending, especially if the alternative is your child covering everyday living costs using personal loans, overdrafts or credit cards.
But that’s a different matter – the important thing is that at age 18, JISAs automatically mature into adult ISAs, allowing your child to continue saving, or to access their funds to spend if they wish.
Whatever you decide, remember only to save money you have going spare, especially if you’re locking it away until your child’s 18th (or 68th) birthday.
Saving for their adulthood or retirement should not come at the expense of childhood financial security – so if needs be, save slightly less or split your deposits between pensions or JISAs and more conventional savings accounts that offer penalty-free instant access.
Finally, as a middle ground compromise, you could consider annual regular saver accounts that pay a lump sum of interest at the end of a 12-month period, in return for meeting regular minimum deposits.
These can be a relatively safe way to get a higher interest rate, with your money only locked away for up to a year at the most – and a significantly shorter period of time for the deposits you make later into that year.
Disclaimer: The information provided here is not investment, tax or financial advice. You should consult with a licensed professional for advice concerning your specific situation.