Three benefits of starting a pension for your child or grandchild

Article written by Kellands Hale, our preferred independent advice firm.

This article is not intended to be financial advice to any individual. The views expressed are those of the author and Moneyfactscompare.co.uk does not endorse the content.

In a world of rising costs, saving for retirement seems to be a difficult task for many young people – potentially leaving them in a precarious position for retirement.

So as a parent or grandparent of young children you may have already spent a lot of time thinking about how to invest for their future.

One such investment option is to open a private pension pot on their behalf and begin making savings that they could benefit from decades in the future.

As of 2023/24, parents and grandparents can pay up to £2,880 into a pension fund for a child or grandchild under 18 each tax year. After earning tax relief, this is effectively boosted to £3,600. If the child has earnings, you can pay tax-relievable contributions of up to £60,000 a year, or 100% of the child’s earnings, whichever is lower.

If you’re searching for ways to ensure your children and grandchildren have a foundation of wealth to rely on later in life, read on to find out three undeniable benefits of starting a pension for your child or grandchild.

In today’s world, with costs rising in almost every area of our lives, it can be difficult for the younger generations to put money away for the future.

Research published by Standard Life, an insurance group, claims only one-quarter of millennials have done “a great deal of planning or thinking” about later life. Millennials, as defined in this study, are people aged between 25 and 40. 

This may come as a surprise, but with the heightened inflation you may empathise with the young people in your life who are struggling to save.

So, helping your young family members by creating a child pension fund on their behalf could prove invaluable in a time of rising costs and stagnating wages.

While inflationary conditions (and the overall cost of living crisis) might have eased by the time your child or grandchild is able to pay their own pension contributions, giving them a head start on retirement could still be beneficial, no matter the wider socioeconomic landscape at the time.

When you contribute into a junior self-invested personal pension (SIPP), or similar child pension fund, on behalf of your child or grandchild, tax relief is normally applied at the basic rate.

Usually, pension contributions automatically receive basic-rate (20%) tax relief from HMRC. This means a £50 a month contribution would be “worth” £60. As a result, if you contribute the tax-relievable maximum £2,880 in a tax year, this becomes £3,600 due to tax-relief.

So, when calculating how much your child could have by the time they reach adulthood, ensure you factor in the 20% tax relief that is usually applied to pension contributions. This additional boost can make a supreme difference to your child’s wealth by the time they begin making contributions of their own.

Ultimately, if your child or grandchild enters the world of work at the basic rate, as many do, they may not be contributing much into their pot. But with an existing pension that has benefited from tax relief for a number of years, they could build up their fund more quickly as they head towards retirement.

Establishing a nest egg for your child can not only give them a head start, but it could also make their own contributions more valuable later in life. Remember, a pension is an invested asset – so the larger the pot, the more likely it is to see substantial investment growth.

For instance, a three-year old child having £75 a month paid into a junior SIPP, receiving basic-rate tax relief and averaging returns of 4% a year, could mean they have a pot worth £22,000 by the time they’re 18.

Simply put, this foundation could make all the difference when they enter the world of work. Here’s why.

Let’s say that, in their first year of employment, your child contributes £150 a month (or £1,800 a year) into their pension, including employer contributions and basic-rate tax relief. In this first year, their pension pot sees 4% investment growth.

If they started from scratch, a 4% return on £1,800 would leave your child with £1,872.

However, starting with their £22,000 foundation and adding £1,800 in their first year, your child could see almost £1,000 in investment returns as opposed to £72. This brings their pension wealth to £24,752 – and that’s after just one year contributing at the basic rate.

So, starting your child or grandchild on their pension investment journey early in life could truly “supercharge” their pension wealth throughout their career, making each contribution more valuable as the years go by.

If you are planning to start a pension for a child or grandchild, discussing this move with your Kellands financial planner could be extremely helpful.

Remember: a pension is an invested asset, with no guarantees of returns in the short or long terms.

In addition, contributions made by a parent or grandparent could utilise the Inheritance Tax (IHT) “gift from income” exemption. Here, the gifts you make as pension contributions may fall outside of the value of your estate as long as they are regular, made from your income (not capital), and don’t reduce your own standard of living. Seeking professional advice in this area could be hugely constructive, so that you remain aware of the potential tax implications of paying into a child or grandchild’s pension.

Moreover, it is important to configure your pension contributions on behalf of a child or grandchild with your own wider financial circumstances. In addition, your child will only be able to use these funds in retirement, not before – so it could be worth ensuring you have other wealth set aside to help them earlier in life if you want to.

We can help you set up and manage a pension fund on behalf of a child while factoring these payments into your comprehensive financial plan.

Are you looking to set your children and grandchildren up for the future? We can help. Email us at hale@kelland.co.uk, or call 0161 929 8838.

Please note

This blog is for general information only and does not constitute advice. The information is aimed at retail clients only.

A pension is a long-term investment not normally accessible until 55 (57 from April 2028). The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Past performance is not a reliable indicator of future results.

The tax implications of pension withdrawals will be based on your individual circumstances. Thresholds, percentage rates and tax legislation may change in subsequent Finance Acts.  © Kellands (Hale) Limited is authorised and regulated by the Financial Conduct Authority. FCA Firm Reference No. 193498