It’s never too early to start building a nest egg for your child. Putting money aside when they are young – even before they begin school – can build financial security and help to provide them with a comfortable retirement.
A recent report from the International Longevity Centre (ILC) found that a third of Generation X – over four million people – could find themselves retiring with minimal incomes. Half of those expect to be solely reliant on the State Pension, currently just over £9,000 a year.
Meanwhile, a survey from Which? confirms that one in ten retirees are overestimating the size of the State Pension, some by as much as £50,000 throughout their retirement.
Starting to save early could help your child’s fund achieve massive growth and avoid a pension gap when they come to retire.
Here are three reasons why starting a pension early is a good idea, and one additional factor to bear in mind.
1. Pensions are a tax-efficient way to save for your child’s future
The government incentivises pension saving by making them particularly tax-efficient. This is true for your pension, and for one that you open on behalf of your child or grandchild.
The Annual Allowance is a limit on the amount you can contribute to a pension and still receive tax relief. For the 2021/22 tax year the limit is £40,000, or 100% of the pension holder’s salary, if lower.
If you are contributing on behalf of your child, and they are not earning, pension tax relief is available on contributions up to £3,600 a year gross. That means you contribute £2,880 a year into your child’s pension.
This contribution is below your £3,000 annual gift exemption so could mean your contribution remains outside of your estate for Inheritance Tax (IHT) calculation purposes.
Under current pension rules, your child will be able to access 25% of their accumulated pot tax-free at retirement.
2. Your child’s pension will benefit from decades of compound growth
Whether or not Einstein called compound interest the eighth wonder of the world, it could still have a massive impact on your child’s retirement fund.
Compound growth means not just benefiting from returns on the money you invest, but also the returns on those returns.
Let’s say you invest £1,000 for your child with growth at 5%. In year one your fund increases by £50. By year two, you’ll receive 5% on £1,050, meaning growth for the second year of £52.50. This effect, multiplied over the decades of a pension policy, can lead to huge fund increases.
American investment company Morningstar suggests that a single contribution of £3,600 at birth could grow to a pension pot of £90,000 by the time your child reaches age 66. This assumes 5% average growth and factors in charges but not inflation.
Using the same assumptions, a contribution of the full £3,600 a year for your child’s first 18 years could amount to more than £1 million when your child retires.
3. Teaching the importance of saving for the future could lead to additional savings
The Annual Allowance – the amount that can be paid into a pension while still benefiting from tax relief – is £40,000. This dramatically increases the contributions your child can make when they enter full-time employment.
The concept of “paying your future self first” is an important one in financial planning. Setting your child up with a great financial start in life could instil good habits for the future.
With a growing pension pot as a foundation, your child will have additional freedom to save and invest towards earlier life milestones like education and a first house.
Money in your child’s pension is only accessible at retirement
Saving for retirement is important but if you want to build a nest egg for your child to use early on in life, a pension will not be the right option.
The current minimum retirement age is 55 (rising to 57 in 2028) so money held in your child’s pension will be tied up until then.
To help them through further education or onto the property ladder you might consider a Junior ISA (JISA). The money held in a JISA can be accessed much earlier but remember that a pension is hugely important too.
You will likely find that a combination of a pension and a JISA works best. Make the most of pension contribution limits and the JISA subscription limit (currently £9,000). This will mean you can provide financial help as your child is growing up and offer stability into adulthood and later life.
Get in touch
If you’d like to build a nest egg for your child, a pension can be a great way to provide financial security. The timescales involved, combined with the effects of compound growth, could see your child set up for a comfortable retirement.
We can help you arrange and manage the retirement plans for you and your child so please get in touch. Email at firstname.lastname@example.org or call 0800 0787 182.