Anybody from a new-born baby until they are in their 70s can have a pension – you can even set one up in your baby’s name and pay into it from the day of their birth!
The beneficiary can’t access their pension until retirement age, so your children can’t use it to buy a car or a house or to pay for university. So why would you consider starting one for your child?
The answer is compound interest, which Albert Einstein described as the eighth wonder of the world, and with very good reason. Compound interest means receiving interest on your original capital plus the interest it earns; think of it as ‘interest on your interest’.
It makes your money grow exponentially, and over the long-term the benefits are huge. How huge? The impact can be mind-blowing, as we can see by using an example where you start a pension for your child maybe by saving some of your Child Benefit payment?
If you saved £50 per month (£40 from you and £10 tax relief from the government) into a pension for your child from birth until they turn 25, you’ll end up putting £15,000 into the pot.
Assuming growth of 7% per year – global stock markets have averaged around 9% over time, so this is a reasonable assumption – when your child reaches retirement at around 67 years old, that £15,000 will be worth an incredible £1million. That’s with no more contributions after their 25th birthday. What a legacy to leave them! They may not remember what you spent the Child Benefit on, but they will remember the £1million fund.
On the flipside: if you were to wait until turning 40 before starting a pension, over the same 25-year period as above you’d need to save nearly 20 times more, £922 per month (£740 before tax relief), to reach the same £1m at retirement. That’s £276,000 saved in total compared to the £15,000 needed if starting from birth.
That’s the magic of compound interest. It’s why one of my favourite money sayings is that the best time to start saving for your future was yesterday, and the second-best time is today.
Most stakeholder (personal) pension plans will allow contributions for babies and children. There are plenty of places you can set one up online, and the advantage of a stakeholder pension is that fees are low.
The amount you can contribute annually into a pension varies and is generally linked to your earnings, however for children, or those with no income, it’s £3,600pa gross. Gross means it includes the tax relief HMRC will add to the pension payments, even if you don’t pay tax like children. So you can pay, on behalf of a child, £2,880 and HMRC will add 25% or £720 so £3600pa can be saved. These are the maximums children can put away, you can fund much less to make it affordable.
You can’t access a pension until you retire, so other wrappers such as a Junior ISAs, ISA or general investment account should be used if you’d like to save to help your children with the cost of a wedding, education, property and so on.
The money in a pension is effectively ‘locked away’ until retirement age (currently 55 years old but rising in the future to be 10 years before the state retirement age) which should be seen as a positive thing, because it protects it for the time when it’s needed most: when we’re no longer working but still require income to do the things we want to do.
Now, then, them
Before you rush off to start a pension for your kids, you must take care of your own finances first. Like the safety instructions on a plane – secure your own oxygen mask first before you help others – the same is very much true of finances: you must secure your own future before you plan for your children’s.
I use a saying: now, then, them. Sort out your finances now; then sort out your own future and retirement plans; and only after that should you worry about ‘them’.
If you don’t, you’re potentially going to be a financial burden on your children and that’s not what you or they want. By getting yourself organised, you can marvel as Albert did at the wonder of compound interest.
As parents and grandparents, we give kids pocket money and other treats all the time. Imagine if this was the legacy we gave them instead? You might not be around when they start drawing their money, but they’ll sure remember you for it!
Even if you can only afford to put away £10 per month, something is better than nothing. Quarter of a million pounds is still more than double the average pension pot saved by those now aged 55-65, according to recent research.