I’m looking at different savings options for children. How do pensions for children work and are they a good way to save for their future?
When saving for children, people tend to think about putting money away in instant access accounts or ISAs, but did you know you can also save into a pension for a child? Although their retirement is in the distant future, by saving money for it now, this could mean that they do not need to save so much personally for their later life. The younger generation face a great deal of financial pressure as they get older, so giving their pension a boost now could be extremely helpful.
A pension can be opened on behalf of a child from the day they are born until they reach the age of 18. The pension must be taken out by a parent or guardian, but anyone else can contribute to it. The parent or guardian who took out the pension is responsible for its ongoing management and can make any necessary investment decisions until the child’s 18th birthday.
At this time, control of the pension will automatically be passed to the child. They can then decide if they want to start making personal contributions into it and can make decisions themselves around what funds they want the pot to be invested in.
Children’s pensions benefit from generous tax relief so there is a limit on how much you can pay into them each year. Currently, this limit is set at 100% of the child’s earnings (if applicable) or £3,600 – whichever is the lower amount. The contribution counts towards the child’s annual allowance. Contributions paid on behalf of the child are paid net of basic rate tax, so if the child is non-earner, which is usually the case, the maximum amount payable would be £2,880. With the addition of 20% tax relief from the Government this would make a total contribution of £3,600.
Please remember prevailing tax rates and reliefs depend on your individual circumstances and are subject to change.
As with all other private pensions, the money from a child’s pension cannot be accessed until they are 55 years old. This minimum age is increasing to 57 in 2028, and it could rise again in the future. It’s important to bear this in mind when thinking about how you want your money to help the child in the future. If you want them to have access to the money when they are 18, you may want to consider putting it into a Junior ISA or a trust.
If you contribute the full amount of £2,880 into a child’s pension every year from when they are born until they turn 18, this could potentially give then a pension pot valued at more than £750,000 by the time they reach 57*.
Such a substantial sum could set them on the path to a long and very enjoyable retirement without having to make large pension contributions themselves. But you should always bear in mind that this sum wouldn’t be guaranteed. There is a risk with all investing, the value can go up and down and you may get back less than your original investment.
In addition to providing a healthy start to their retirement, contributing to a pension for a child could provide them with tax benefits in the future.
If the child becomes a higher-rate taxpayer in adulthood, they can claim higher-rate relief on any pension contributions made by their parent(s) or another third party individual, including grandparents, relatives or friends, and reduce their tax bill. They will need to do this through their self-assessment tax return. For example, a father could pay a £16,000 contribution into his adult daughter’s pension. This would be grossed up to £20,000. As she is a higher-rate taxpayer, the daughter can claim additional tax relief of £4,000 on the contribution via her tax return, even though the contribution was paid by her father.
Also, if the child goes on to become a parent and they earn over £50,000, they could be impacted by the high income child benefit charge. This charge is applied if either they or their partner receives child benefit. In these instances, any money contributed to the adult child’s pension by their parent(s) or another third party individual is deducted from the adult child’s income before this charge is calculated.
For example, if the adult child earns £60,000 and they receive child benefit, they will face a child benefit tax charge of 100% of their child benefit amount. A pension contribution by the parent of the adult child of £8,000, which would be grossed up to £10,000 by tax relief, would reduce the child’s income to £50,000 for the purposes of the child benefit charge and would therefore remove it under current legislation.
Pensions are not only a cornerstone of retirement planning, but they can also form a key part of estate and Inheritance Tax planning. If you are a member of a defined contribution scheme and you die before you reach the age of 75, regardless of whether you have made any withdrawals from your pension, you can pass it on to a child, or another beneficiary of your choice, free of Inheritance Tax and Income Tax. If you die after the age of 75, even if you have not already accessed the pension, it can be passed on free of Inheritance Tax, but the beneficiary will pay Income Tax on it at their marginal rate.
If you’d like to know more about pensions and investing for the children in your life, please book a free initial consultation online or call us on 020 7189 2400.
Bestinvest offers a Self-invested Personal Pension (SIPP)** that can be opened for a child.
This article does not constitute personal advice. If you are in doubt as to the suitability of investing into a pension, please contact one of our advisers.
Issued by Tilney Financial Planning Limited.
* This figure is based on an investment return of 5% per annum after fees, compounded annually. You should note that investments can go down as well as up and it is possible to get back less than originally invested. Examples of how tax or tax relief may apply are based on our understanding of current tax legislation. Whether any tax will be payable, at what level it is charged and whether you qualify for tax relief will depend on individual circumstances and may be subject to change in the future.
**SIPPs are not suitable for everyone. They may not be right for you if you don’t want to invest across different asset classes or don’t think you will make use of the investment choices available to you. Please contact us for guidance or advice if you are unsure.