Pensions for Children

You may be surprised to know that over 65,000 children now have pension plans (Source: HMRC). Due to the tax benefits involved, it is quite easy to see why this is seen as particularly attractive for families who can afford to lock up capital for 50 years or more.

Thanks to the effects of compound interest, the combined benefits of tax relief on contributions and tax-efficient growth, the potential exists to provide your child with a pension pot of £1m or more. Only, however, if you consider commencing saving in the years immediately after he or she is born - the rules allow you to start a pension for a child from birth and you do not need to be a relative.

Whilst most people only begin to save for retirement after they have started working, starting to build a pension pot at birth dramatically increases the eventual size of the potential pension fund and, therefore, the potential income in retirement.

So how does it work?

Firstly, you can put a maximum of £2,880 into a personal pension for a child each tax year. The Government will add £720 in tax relief, boosting the value to £3,600. The investments then grow free from income and capital gains taxes.

Assuming investment growth of 6% per annum (after charges), you would need to make this contribution for just the first 18 years of the child's life to generate a £1.8m pension pot. Your actual outlay over that period would total £51,840, with £12,960 added in tax relief.

Better still, the £2,880 yearly contribution falls below the £3,000 annual gift limit for inheritance tax (IHT). Consequently, this removes the money from your estate for tax purposes even if you die before the normal seven-year threshold.

After taking inflation into account (at an assumed 2.5% per annum), a £1.8m pension pot would be worth about £356,000 in today's terms – enough to buy an index-linked annuity of about £15,500 a year. (Source: Aviva)

What is the impact of delay? If, instead of starting the pension at birth, your child starts contributing once he or she starts work, saving the same £3,600 every year from the ages of 25 to 65, they will end up with a pension pot worth only £590,600 before taking inflation into account, rather than £1.8m. This is despite them saving for 40 years instead of 18.

This demonstrates that those early contributions can pretty much relieve your children of the sort of retirement worries that are a concern to many people today. Pensions do not have to be of exclusive interest to those later in life; you can have one from birth - if you are fortunate enough to have parents or grandparents who set one up.

Until relatively recently, many employees could count on generous, virtually risk-free, final-salary pensions, as well as free university education and the likelihood of benefiting from the house price boom. Today's children are more likely to have debts from the cost of further education and less generous defined-contribution workplace pensions to fund their retirement.

As people are generally living longer and as a consequence, will be retired for much longer, an adequate income becomes even more important. In future it may be harder to top up pension arrangements from personal resources, as a result of repaying student loans and struggling to get a foothold in today's much more expensive property market. Would a pension started at birth by far-sighted relatives help to redress the balance?

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