- What is a children’s pension?
- Why would you set up a child’s pension?
- When can children access their pension?
- Is a children’s pension the best way to save for grandchildren?
- How much can you pay into a pension for a child?
- How much could a child’s pension be worth?
- When can it be accessed and what are the drawdown rules?
- What are the disadvantages of a children’s pension?
- Should a children’s pension be included in estate planning?
Many of us consider pensions to be exclusively for working age adults, but that’s not always the case. Children’s pensions are also available and can enable parents, grandparents, and carers to secure the long-term future of the next generation. Here, we explore how a child’s pension works, the pros and cons to you as a contributor and how much it could be worth in the future.
Fundamentally, it’s the same as a pension for an adult, but it has to be set up by the child’s parent or legal guardian. Once it’s been arranged, anyone can contribute to a child’s pension fund.
Children’s pensions have tax breaks and are also subject to the same sort of rules when it comes to accessing the funds. A child’s pension is also known as a Junior SIPP (self-invested personal pension).
If you’re a parent or legal guardian, setting up a child’s pension provides them with an extra layer of financial security, knowing that they’ve got a considerable head start for their own retirement. While that might seem a long way off, it means your child may be able to reduce the additional burden of juggling pension payments on top of student loans, rent, mortgage, or other day to day expenses.
Any amount paid in will benefit from returns that are compounded, meaning that even if the child didn’t continue to pay into the pension as an adult there would still be the potential for the pension fund to grow over the years.
Parents and guardians are responsible for managing a child’s pension until the child turns 18. When that happens, control automatically reverts to the child. The fund itself cannot be accessed until retirement age – currently set at 55 but due to increase to 57 in 2028.
Whether you’re a parent, grandparent, guardian, or other family member, contributing to a child’s pension can be a good way to contribute towards their long-term financial security. Other benefits include:
This is when income is earnt on both the amount invested and any returns that have previously accumulated. For example, if you have £1,000 and put it into a pension earning 5% annual returns, by the end of the 12 months, you’ll have £1,050. The following year, the 5% return will be applied to the full amount. So, by the end of the second year, you’ll have £1,102.50.
Please note, most pension funds are held in investments that can go down as well as up and the returns are not guaranteed.
Pension contributions qualify for 20% tax relief. This mean that if you contributed the full £2,880 allowance per year, the tax break means it actually works out at £3,600.
As the child’s pension cannot be accessed until retirement age, more thought can be given to how that money is spent. This is in contrast to other savings and investments, such as a junior ISA, which is accessible when the child turns 18. A child’s pension is a long-term investment.
You can pay up to £2,880 into a children’s pension every year. With government tax relief, this increases to £3,600 annually.
If a child’s pension is set up at birth, after 18 years, that could equate to £96,016 based on paying in the maximum every month, plus tax relief and compound returns of 4% each year. Even if your child leaves the pension to tick along, the total amount in the fund could be worth more than £600,000 by the time the child reaches 65. This again includes compound returns and assumes a fund that grows an average of 4% each year.
This example is based on continual returns of 4% a year. Most pension funds are held in investments that can go down as well as up and the returns are not guaranteed. Please also bear in mind that the value of the pension pot would be adjusted depending on the level of inflation at the ‘child’s’ retirement age.
Children’s pensions follow the same rules as adult pensions so the fund can’t be accessed until retirement age. Under current guidelines, your child will be able to access the money by:
- withdrawing some or all of the fund;
- using the pension pot as a drawdown fund, so that money is taken from it when needed but the bulk of it remains invested and continues to potentially grow;
- buying an annuity which guarantees an income for life.
Of course, where there are advantages, there are disadvantages too, for example:
All investments come with risk and there’s never any guarantee that a children’s pension will meet particular expectations.
Despite being a plus point, restricted access also has its downside as funds cannot be accessed until the child reaches their own retirement. Alternative options like a junior ISA or trust fund that can be accessed much earlier, enables the child to make their own financial decisions.
Not only that, there’s nothing to say that the retirement age won’t continue to rise which will leave the fund inaccessible for longer than first thought.
Burden of expense
Setting money aside for a children’s pension inevitably means diverting money that could otherwise be spent on everyday costs. Whether that’s mortgage repayments, living expenses or university fees, contributions to a child’s pension add up, and are an extra financial commitment that could become a burden. Of course, you don’t have to contribute the full allowance, different providers will have different rules on the minimum amount required to be paid in each month, but you may have the flexibility to adjust the contribution to what is affordable for you.
For parents and grandparents, contributions to a children’s pension could be worth considering as part of this. In fact, gifts to a children’s pension could be an effective way to reduce the size of your estate and in turn, lower inheritance tax.
Whether a children’s pension is the best way to save for your grandchildren or children, comes down to your own circumstances. The crucial point is that it’s important to look at your assets and financial situation from a long-term perspective.
To do this, you can speak to a qualified independent financial advisor (IFA) at Alan Boswell Group. Our tailored approach to wealth management means we’ll assess your current position, and give you suitable options that enable you to meet your financial goals. For more information about how we can help, speak to a member of the team on 01603 967967.
The value of investments and any income from them can go down as well as up and you might not get back the original amount invested. The past is not a guide to the future.
The value of tax benefits depends on your individual circumstances. Tax laws can change.