A lot has been said about the importance of saving for retirement but have you ever thought about starting a pension for your kids?
A child could become a millionaire by their 43rd birthday if you save £240 a month 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, which amounts to £2,880 a year – the maximum yearly contribution limit – 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.
But your child will need to get lucky with investment returns and make a hefty 8 per cent a year from the stock market.
Making monthly contribution of £240 in a pension for the first 18 years of your child’s life could result in a nest egg of over £1million according to research by Brewin Dolphin
The calculation is based on a total contribution of £51,840 and the assumption that the pension pot will grow by 8 per cent a year.
While this may seem high, data from Moneyfacts, the comparison website, showed the average pension fund grew by 10.7 per cent in 2017 and they have experienced double-digit growth for six consecutive years.
The research also takes into account the generous 20 per cent top-up applied to contributions by the taxman – even though children don’t earn. So £2,880 turns into £3,600 after the tax relief has been applied.
Can’t afford that much? £50 could grow to £213,000
In truth, not everyone can afford to squirrel away £240 a month in a pension for their tot, but contributing a smaller amount could still yield a handsome sum come 2061.
Investing £50 and £100 every month could create a pot of £212,883 and £425,766 respectively (again assuming 5 per cent a year growth rate and net of fees).
This could be a good thing for grandparents to get involved in as parents might need to be saving for their own pension. Grandparents can gift unlimited amounts from excess income free of any inheritance tax risk.
What’s more cash drip fed into a pension at an early stage could work harder than if it was handed down as an inherited lump sum.
The former strategy could benefit from substantial investment growth – bolstered by the effects of compounding which generates further returns on reinvested earnings.
Douglas Cameron of Brewin Dolphin, said: ‘Despite its obvious advantages, contributing to a family member’s pension is one of the last thoughts to cross the majority of people’s minds.
He added: ‘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. But, pension contributions guarantee that their children won’t be able to use the proceeds until they are pensionable age.’
Why it might not be a good idea
A key risk to pension savings is politics.
Pensions have historically been treated as a political football. Past governments have been guilty of tinkering with pension policy to score some votes. This creates uncertainty over future withdrawal rules.
The Tory government under David Cameron introduced attractive flexibilities while maintaining the key pension saving carrot: the tax relief. But who’s to say that the reforms will not be whittled down or even scrapped under future governments?
The popular pension flexibilities were introduced by David Cameron’s Conservative Government in 2015
It’s also worth flagging that the age in which you can access your private pension without penalty has been pushed back in recent history.
The minimum pension age was 50 before 6 April 2010 before rising 55 – the current threshold. It’s due to increase again to 57 in 2028.
Nobody knows what the future hold, but another hike is not beyond the realms of possibility.
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 £1,003,000 at present. It may increase in future or it could fall – nobody knows. It has been reduced from £1.5million to £1million and jumped to its current level in the past three years alone.
Your child’s pension may well breach the limit regardless if you do aim to make them a pension millionaire.
This would mean that any amount accrued above the allowance would incur a tax charge of up to 55 per cent under current rules.
Furthermore, 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.
Saving into a junior Isa, or Jisa for short, could be the ideal solution in this instance.
Up to £4,260 can be paid into these tax-free wrappers in the current tax year. The cash is locked up until the child reaches the age of 18 – at which point, the account turns into an adult Isa and control of the account is transferred to them.
Alternatively, you could save for your child in an ISA under your name. Doing so allows you control when you gift your child money from it.
You could even use the funds to make payments on their behalf – paying off university fees for example.
Where to invest
There is also a new breed of wealth managers, called robo-advisers, which put you in a portfolio that closely maps your attitude towards your finances and risk.
Some offer Sipps (self invested personal pension) but their investment range tend to be limited – with a skew towards tracker funds, which aim to replicate the performance of a given market index like the FTSE 100.
Another sticking point is data on the portfolios’ performance are hard to come by, which makes comparison difficult.
For more information, read our guide on robo-advisers.
You can set up a pension for your child directly through a number of pension providers but for maximum flexibility on where you can invest, it is probably better to use an online broker.
Be warned though, broker charges apply and you should check these carefully as they could seriously eat into the investment returns.
In addition, while some platforms offer investment guidance, no actual advice is given and you’ll be left to building a portfolio from the myriad of funds, exchange traded funds, stocks and investment trusts.
To help you on your way, we’ve asked Darius McDermott of funds rating company Fund Calibre and Adrian Lowcock of investment broker Willis Owen to recommend some funds to consider.
Some expert fund ideas
AXA Framlington Global Technology – ongoing charges 0.83 per cent
We like this fund as it is unconstrained and can invest in companies of all sizes. The fund manager tends to avoid investing in mature technology companies, which should normally mean a fund like this would have high volatility.
However, the diligent and rigorous process employed, along with AXA’s global resources, has enabled the fund to achieve a lower volatility in the past.
For those wanting to invest a little closer to home, smaller companies can be good for the long term as they tend to outperform – the growth potential is much greater than that of a larger company.
True to its name, Livingbridge UK Micro Cap fund invests in some of the UK’s smallest listed companies. The manager aims to invest in companies that can double their earnings over a five-year period and he avoids high risk sectors such as oil, mining and property.
Livingbridge has experience of working with companies and management teams before they come to the stock market and this can give them an advantage over their peers.
F&C Global Smaller Companies (investment trust) – ongoing charges 0.83 per cent
For those willing to take a bit more risk, this trust aims to achieve a high return by investing in small companies from around the world.
F&C’s small company specialists have a well-disciplined investment process and the trust has a strong track record of beating the market.
L&G International Index Trust – ongoing charges 0.13 per cent
Legal and General have a long and established history of investing passively and are well resourced to provide investors an excellent global tracker.
The fund aims to track the FTSE World (ex UK) index by investing directly in the companies in the index. The ongoing charges are low at 0.13 per cent.
Fidelity Emerging Markets – ongoing charges 0.96 per cent
The fund invests in companies with superior business models that demonstrate strong and sustainable profitability and a consistent track record over time.
Its manager, Nick Price, looks for confirmation of quality through superior and sustainable return on assets, strong balance sheets, track record and valuation.
Price prefers self-funding businesses which treat shareholders fairly. He is also interested in companies with long term growth potential where reinvestment in that growth delivers a high rate of return.
Liontrust UK Smaller Companies – ongoing charges 1.36 per cent
Managers Julian Fosh and Anthony Cross look for companies with a lasting economic advantage over their competitors that they believe deliver a higher than average level of profitability for longer than expected.
They look for companies with intellectual property, strong distribution channels and recurring business.