Investing in a child’s future could set them up for more than just a wealthier retirement.
Benefits of an early start
The benefits of taking a long-term approach to investing are time-tested and the principle is very simple: the longer an investment has to grow, the greater the benefit will be from the year-on-year compound effect of reinvested returns. So starting a pension for your child might be one of the best things you ever do for them.
Costs of having children
Having a child or children is an expensive business, especially in the current economic climate when low wage growth and rising prices and ultra-low interest rates have made many budgets even tighter.
The cost of bringing up a child from birth to the age of 21 has been calculated by the Centre for Economic and Business Research as almost a quarter of a million pounds.
The average home costs less.
When the cost was first calculated in 2003 the cost was £150,000.
All of these financial challenges mean that many parents will put off the idea of building a nest egg for their children until better times arrive.
But if your aim is to help a young child save for a distant goal, university, home ownership etc. then the earlier you start saving the better.
One of the most important concepts to understand if you want to manage your finances well is Compound interest, which is the key to growing wealth.
Albert Einstein called compound interest the eighth wonder of the world explaining that people who understand it, earn it, and the people who don’t, pay it.
The secret is to start saving into a pension as early as possible, even with relatively small amounts, to take advantage of it.
The Junior ISA (JISA)
The Junior ISA (JISA) is perhaps the most popular.
A JISA is an ideal way to provide money for a future house deposit or university fees. Less well-known is that children can also have a pension fund as soon as they are born – and setting one up can bring significant tax advantages.
More than 10,000 children already have pension plans in place, according to HM Revenue & Customs.
Even if your child is a non-taxpayer, they will still get basic-rate tax relief on contributions. That means a maximum of £2,880 a year is automatically grossed up to take account of tax at 25%, giving an annual investment of £3,600.
The impact that starting early can be quiet extraordinary
Saving £5 per day from the day the child is born until their tenth birthday would cost just over £18,000 depending on leap years, but would have the potential to create a £1 million pension pot by the time they retire.
Of course there are conditions attached to this sort of prediction.
- It assumes that there will be an average growth rate of 5% a year.
- Your child continues to contribution at a total of £300 a month once ownership transfers to them at age 18.
You should also remember that the success of any investment is not guaranteed. The value of an investment will be directly linked to the performance of the funds that you invest in, and the reality is that you may get back less or even a lot less than the amount invested.
Just as with pensions for adults, pension pots for kids grow in a tax-advantaged environment.
And in common with JISAs, although the JISA mus be set up by the child’s parents or guardians, once it is up an running anyone can pay into the pension on the child’s behalf – parents, grandparents, godparents, friends or other family members.
Inheritance tax advantage
Setting up a JISA can be a good way to manage inheritance tax liabilities as the conributions made by a grandparent for example may be covered by the annual £3,000 IHT gifting allowance, or the exemption for payments made out of income.
One of the big problems facing the current working generation is their lack of fiancial knowledge and their limited understanding of how modern financial services work.
Children gain financial literacy in the same way as they learn to read, but doing it. Saving habits are like many other things, learnt by the age of seven.
Surprisingly young children, especially those from homes with low levels of financial literacy are rarely given lessons on either budgeting or money management.
But, helping a child to fund their own pension could be one way to help them understand concepts such as compound interest
Helping your child build their financial literacy by having these sorts of savings will help them to be able to proactively manage their finances and help them to create a more secue financial future.
Financial literacy could the best investment you can make to secure their financial future.
Setting up a pension or JISA for your children could help them out long before they think about accessing the money, which current rules allow them to do at age 55.
KNowing that there is an investment in place for the long term will mean that when they start working and setting up their own home they have one less thing to worry about.