Children's pensions: should you save for junior?

published 20 July 2018

905_MW_P23_Pensions — There are better ways to lend a helping hand

Starting a pension for your child might not be the best option

Some children still in short trousers are well on their way to building up a handsome retirement fund. Tens of thousands of parents are giving their children a helping hand by saving into a child's pension for them. However, this won't be the best option for everyone.

There are, of course, good reasons to consider starting a child's pension. Most obviously, there is free money available from the taxman: everyone, including children of any age, may put up to £3,600 into a pension plan each year and receive basic-rate tax relief of 20%. This means the maximum investment costs parents only £2,880, with the pension provider then applying to HM Revenue & Customs for the tax relief.

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What's more, the investments that most people make via pension plans tend to deliver the best returns over long-term periods. Since children have many decades to go until retirement, there is plenty of time for compound interest to work its magic on even modest contributions.

Another argument in favour is that it may be many years before they can make their own contributions. Even once they're earning, obstacles such as student debt repayments, the need to save for a deposit on a first house, or measly salaries at the beginning of their careers may get in the way.

Think long term

However, there are counter-arguments. Firstly, just as your children are likely to have other priorities early in their working life, so you may think helping them with their most pressing financial needs is a better option. Pensions are inflexible: children can't use money you've invested in their pensions as a deposit on a house or to pay for a wedding, say.

Also, governments have an irritating habit of changing the rules. While private pensions can currently be cashed in from age 55 onwards, this age limit is due to increase over time certainly to 58 by the 2030s. Your children will have to wait longer to get at their savings. Other reforms may make pension saving less attractive well before then.

It's worth pointing out, too, that the rules on pensions inheritance now make it much easier to pass your own retirement savings on to your children. If you die before the age of 75, your heirs will usually inherit what remains of your savings with no tax to pay even after age 75, you can still pass on pensions, though there will then be tax charges.

If you have some spare cash you'd like to put aside for your children, there are several other options. In the column on the right we look at what you should prioritise.

Ways to give your child a head start

Parents wanting to help their children are better off maximising the savings they put into their own pensions, as well as into tax-free individual savings accounts (Isas). This money can then be distributed to your children when they need it, or inherited, rather than tied up in their own pension.

Another option is to open junior Isas on your children's behalf. These work just like adult Isas, offering tax-free returns on a very broad range of underlying investments, but with a smaller annual cap £4,260 in the 2018-2019 tax year. The child takes ownership of the Isa at age 18 and can then use the cash as they see fit.

Finally, remember that your child may one day want to save into a workplace pension to get the benefitof their employer's contributions so paying too much into a pension now could be counterproductive, as Michael Martin points out in the Financial Times. If you invest the annual £3,600 allowance every year from birth to the age of 25, and the pot grows by 6% a year, it will be worth more than £2m when your child is 65. The lifetime allowance (LTA) is just £1.03m it may be increased in future, but £2m is probably still going to exceed it. That means any further benefits accrued in a workplace pension will be heavily taxed (a 55% tax charge if they withdraw it as a lump sum, and 25% if they take it as an income).

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David Prosser is a regular MoneyWeek columnist, writing on small business and entrepreneurship, as well as pensions and other forms of tax-efficient savings and investments. David has been a financial journalist for almost 30 years, specialising initially in personal finance, and then in broader business coverage. He has worked for national newspaper groups including The Financial Times, The Guardian and Observer, Express Newspapers and, most recently, The Independent, where he served for more than three years as business editor.