Could your child be a pension millionaire?
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A lot has been said about the importance of saving for retirement but have you ever thought about starting a pension for your kids?
Written by Jonathan Wade
Director
A child could become a millionaire by their 43rd birthday if you were to save £240 a month (or £2880 a year, the maximum permitted without earnings) into a pension for the first 18 years of their life, according to new research. After that, you simply allow investment returns to do the rest. These contributions, could create a nest egg of £1,021,837 by 2061 after investment fees have been deducted, the study by wealth manager Brewin Dolphin suggested. This would require a hefty 8 per cent a year returns from the stock market, requiring an aggressive investment strategy which may not be acceptable to everybody, although the very long investment term lends itself to this.
The research also takes into account the generous 25% tax relief applied to contributions by the government - even if children don't earn. So £2,880 turns into £3,600 after the tax relief has been applied.
Can't afford that much? £50/m could grow to £213,000
In truth, not everyone can afford to contribute £240 a month in a pension for their child or grandchild, but contributing a smaller amount could still yield a very worthwhile fund on retirement. Investing £50 and £100 every month could create a pot of £212,883 and £425,766 respectively (again assuming 8 per cent a year growth rate, net of fees).
This is a particularly attractive thing for grandparents to get involved in, as they often have more surplus income than hard-stretched parents, and there is the additional attraction that they can gift unlimited amounts from excess income free of any inheritance tax risk.
These projections demonstrate the power of compound-growth, where returns are magnified by reinvesting growth, and tax relief at source, over a long time scale.
Despite its obvious advantages, contributing to a family member's pension is one of the last things many people consider. However, one of the biggest obstacles to passing on wealth tends to be the parents or grandparents worrying that their younger family members will 'waste' the money on frivolous purchases. Pension contributions guarantee that their children won't be able to use the proceeds until they are of pensionable age. Currently, pension funds can be accessed from age 55, although that is set to rise to rise to 57 in 2028.
Why it might not be right for you?
Pension freedoms have made pensions far more attractive to many people by scrapping restrictions on accessing funds (after age 55), but there is always the possibility that pension freedoms or tax reliefs could be be whittled down or even scrapped under future governments.
Another thing to be aware of is the lifetime allowance - the maximum amount that can be drawn from a pension without facing a tax charge. The limit is £1,073,000 at present. The stated intention is that this increases annually but nobody knows what future governments may do. However, you should be aware that your child's pension may well breach this limit, depending on what contributions they make themselves over their lifetime in addition to the contributions you make on their behalf. This would mean that any amount accrued above the allowance would incur a tax charge of up to 55 per cent under current rules.
Probably the biggest consideration is that while pensions are extremely tax-efficient, they cannot be accessed until age 55. If you believe that your child would need the cash sooner (to help fund the purchase of their first property, for example), a pension isn't the way to go. In that case, saving into a junior Isa, lifetime Isa, or Bare Trust, would be an ideal solution.
Finally, investment returns are clearly not guaranteed and are subject to volatility. The growth figures used above would necessitate an aggressive investment strategy and may not be achieved and also may not be in line with individuals’ attitude to investment risk.
We would be happy to discuss these options so please get in touch if you feel they may be of interest.
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Want to know more?​
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Call us for a friendly chat on 01943 871638 or email: info@watsonfp.com
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