Investing for Your Child’s Future
Wednesday, March 10, 2021
As the cost of living rises, there is a growing pressure on the next generation to earn enough money to see them through retirement comfortably. That’s why saving for your child from birth is so important and will enable them greater financial independence when they will need it most. There are a number of ways to save and invest for your children, depending on your attitude to finances and when you want the money to be accessible. If you are unsure on where or how to start saving for your family, seeking help from a professional is the best way to get your finances on track. The Wealth Consultant can find you the best person to help you take control of yours and your family’s financial wellbeing.
Junior Individual Savings Accounts, or JISAs, are just one of the tax-efficient ways you can start to save for your children. According to HMRC, 954,000 JISAs were opened in the UK between 2018-19. JISAs enjoy the same tax-benefits as adult ISAs, which we discussed In our previous blog post.
You can open a JISA for your child at birth and continue to make contributions until they are 18. The current annual allowance is £9,000 which has limitless potential to grow since it is exempt from capital gains or income tax. Your child can start managing their JISA at 16 and can take full control at 18, when their JISA will automatically roll over into an adult ISA. Like other adult ISAs, you can choose to open a Cash or Stocks & Shares JISA. With interest rates at a historical low and inflation rates rising, a Stocks and Shares JISA seems to be the most prudent way to save for your children.
If your child was born between 2002-2011 you may have opened a Child Trust Fund. However, they have since been replaced by JISAs. If you did open a Child’s Trust Fund, you are not eligible to open a JISA at the same time, but you are able to transfer the funds into a new JISA.
Alternatively, you can also opt to open a Junior Pension. Contributing to a pension for your child from birth may seem premature, but one advantage that children have over adults when it comes to saving money, is time. A Junior Pension is a great way for parents or legal guardians to set up long term savings for a child which they will have access to when they reach the age of 55.
Anyone can make contributions and you are entitled to make a maximum annual contribution of £2,880, which is subject to a 20% tax relief top up from the government, giving a total of £3,600 a year. As parents, you are also able to use your annual gift exemption of £3,000 to make the payments, translating into a major inheritance tax saving too, according to Investor’s Chronicle. It is also an excellent opportunity for grandparents to get involved with saving for their grandchildren’s future. Grandparents are able to gift unlimited amounts to their grandchild’s pension from excess income, free of any inheritance tax or their annual £3,000 gift exemptions.
To illustrate the magic of compounding and the growth potential of pensions, Brewin Dolphin demonstrates that putting aside £240 per month from the day your child is born until the age of 18, could result in a pension pot worth over £1 million by the time they reach 43! (assuming an estimated annual return rate of 8%). Your child may not appreciate what you are doing today, but by the time they reach retirement they will be rewarded with a substantial savings pot to help them transition into a comfortable retirement. When they do wish to access the money, they are entitled to a 25% tax-free lump sum withdrawal from 55. This process will enable your child’s financial independence when they are going to need it most.
In truth, not everyone will be able to put aside £240 per month. However, your child can still achieve a million-pound pension at retirement age by investing just £100 per month until they are 18. One way of investing £100 per month is to ask each set of grandparents to contribute £20 and yourself £40. With the government 20% top up you can invest £100 by only spending £40 yourself. Investing this money for the first 18 years of your child’s life and subsequently leaving it untouched to grow at the same estimated return rate of 8%, will yield a pension worth £931,541 when they reach 55! Furthermore, if they leave the money untouched for a further 5 years, it could be worth £1.38 million by the age of 60!* The power of compounding is so strong that just a few years can turn a modest pension pot into one worth over £1 million!
* Notwithstanding this would take them over the current lifetime allowance. However, the lifetime allowance is subject to change so there is no saying for definite what the lifetime allowance will be in the future when your child reaches retirement.
So, what is the cheapest and best way to save for your child, whilst also getting the largest sum by the time your child needs the cash? The answer is that it really depends on your current financial situation and your financial goals. That being said, it is possible to have both a JISA and a child’s pension should you think that they will benefit from the use of both. Not only will a pension or JISA prepare your little one for a stable financial future, but it will help engage them with money from a young age; benefitting them in understanding how to look after finances responsibly. The Times Money Mentor emphasises the importance of the educational aspect and teaching your children about handling personal finances. Doing so will help engrain good money habits from an early age which they will hopefully build on in the future.
The deciding factor is likely to be when you want your child to have access to the money. You may want the flexibility of having access at the age of 18 which may be relevant for a child looking to buy their first car or to go to university for example. Conversely, you may feel more at ease if you left it untouched until they reach 55, by which time it should have grown into a significant nest-egg to help them into retirement.
Another consideration is your attitude to investment. If you are risk inclined, setting up a child pension will allow you the ability to take more risk in your investments as it leaves more time for the money pot to recover as the markets fluctuate. If you are risk adverse a Junior ISA may be more appropriate as investments can be kept low risk to ensure the pot grows until the child is aged 18.
Understandably, not everyone has the luxury of investing £2,880 every year. Whilst it is important to think about saving for the future, it should not come at the cost of your financial needs now. Nonetheless, if you can, the benefits of putting away some money each month will stand you and your family in excellent stead for the future, and even help your child retire a millionaire!
It is also worth remembering that regulations, tax relief and annual rate of returns do change and therefore do not guarantee how well your investments will perform. That being said, historically, putting trust in the markets has reaped higher rewards. Investing money for your children now through a pension or a Stocks and Shares JISA is an effective way of saving money and allowing it to grow tax efficiently for the future. Neither of them will also affect the amount you can pay into your own ISA or pension.
Both have their advantages and disadvantages and it is not a one size fits all situation. It is important to consider your current financial situation and what you hope to achieve in the future. If you feel slightly lost and confused, do not worry, you are not alone! At The Wealth Consultant we can introduce you to the right person to help you make these decisions and enable you to take control of yours and your family’s financial wellbeing.