4 positive reasons investing in a junior pension could secure a child’s future
01/04/2022When you have children or grandchildren, it’s only natural to want the best for them. As part of this you may want to help financially, which might include helping them buy their first home, their first car, or putting money aside to support them through university.
While these are all excellent ways to help younger members of your family, there is another way you could help ensure their long-term financial security: starting a junior pension.
With the tax relief pensions offer and the potential for investment returns over a long period, these pensions can be an excellent way to help boost a child’s financial future.
It could provide the foundation for a pension strategy that helps your child enjoy the lifestyle they want in retirement, while at the same time, offering greater financial flexibility during their working life.
Read on to discover more, and how we can help.
1. Your child’s pension gets a boost from the government
Like adult pensions, if you contribute into a pension for your child, the money you pay in typically receives tax relief. This means that every £100 you contribute actually costs you £80, although the level of contributions that receive tax relief is limited to the child’s Annual Allowance.
In 2022/23, this is the higher of £3,600 gross or 100% of the child’s earnings, if they have any. With the tax relief, you only have to contribute a net £2,880, which works out to be £240 a month if you wanted to pay this way instead.
One way you could start a pension fund for a younger member of the family is to open a junior personal pension. While it needs to be opened by parents or legal guardians, once this is done grandparents or other family members can contribute to it.
2. Compound growth could provide attractive returns
Because of the length of time a junior pension could be invested for, it has the potential to provide excellent growth potential. This is because of “compound growth”, which is where the pension pot enjoys growth on the growth it’s already made.
To demonstrate how effective this could be, consider the following example. It’s taken from Unbiased, and shows how compound growth could really help your child or grandchild when they reach retirement age.
It calculated that if you invest £2,880 (£3,600 with tax relief) into a personal pension in the first year of a child’s life and then every year until their 18th birthday, it could be worth around £95,000. This works on the assumption of an average growth of 4% a year.
Assuming this rate of average growth continues, the pension pot could be worth more than £620,000 (before any administration fees) by the time your child or grandchild reaches age 65 – even if they make no further payments into it.
In contrast, if your child or grandchild starts a pension at the age of 25 and pays £240 a month for 40 years, with tax relief and compound growth, it could be worth around £356,000 – that’s £264,000 less.
It’s worth remembering that, when adjusted for inflation, this £600,000 pot is likely to have the same spending power as £200,000 today. With this in mind, encouraging the youngster to speak with a financial planner and continue contributing is probably a shrewd move.
3. A pension provides flexibility in life
The security provided by a junior pension could offer your child much more freedom when it comes to their life choices. This is because they could work with a financial planner later on to build the pension you’ve started, which may allow them to pursue career options based on lifestyle rather than finances.
It could also help ensure they retire at their chosen age no matter what choices they make as an adult. This could provide a standard of living in retirement that previous generations have enjoyed, but younger generations might now struggle to achieve.
This is particularly important when you consider that a recent article by FTAdviser revealed that 40% of people are only on track for a “moderate” level of income in retirement.
4. A Stocks and Shares ISA may not help your child’s retirement
You may be considering a Junior Stocks and Shares ISA to help your children or grandchildren financially. While these tax efficient accounts offer benefits and allows you to contribute up to £9,000 in the 2021/22 tax year, care should be taken.
The main reason for this is that when the child reaches the age of 18, they have the legal right to access the money in the ISA. While the youngster might be sensible with a significant amount of money at 18, they may not have the life experience to handle it and could, for example, buy an expensive car instead.
This would mean they would have to start a pension later in life, which, as Unbiased’s example shows, could significantly reduce the amount they then have to retire on.
Downsides of junior pensions to consider
Of course, while these four reasons form a persuasive argument in favour of opening a junior pension, there are a couple of downsides to consider.
Firstly, pension rules in the 2022/23 tax year prevent access to a pension until age 55 at the earliest, rising to 57 in 2028. Although this will stop them from wasting the money, that means they won’t be able to use any money you invest into the pot to support them even at important life stages, such as buying a first home or getting married.
Pension legislation is constantly changing too, and the earliest point at which they could access their funds could increase over time. That means their money may be locked away for even longer.
Additionally, while estimates for what the pension will be worth assumes an annualised return of 4%, there’s no guarantee that the investments will generate returns at all. In fact, they may even get back less than you put in if markets perform poorly.
There are significant advantages of a junior pension, but it’s important to also consider these potential drawbacks before you invest money.
Get in touch
If you have children or grandchildren and are considering a junior pension, please contact us at info@douglaswhiteltd.com or call 0151 345 6828.
Alternatively, if you know anyone who might benefit from a conversation about opening a pension for a child, we’d be happy to speak with them to see how we could help.
Please note
This article is for information only. Please do not act based on anything you might read in this article. All contents are based on our understanding of HMRC legislation, which is subject to change.
A pension is a long-term investment. The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Your pension income could also be affected by the interest rates at the time you take your benefits. The tax implications of pension withdrawals will be based on your individual circumstances, tax legislation and regulation, which are subject to change in the future.
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