Updated 03 December 2020
Welcome to the world of Extreme Financial Planning. If you can’t imagine starting a pension pot for a baby, you’re not alone. But thanks to their ultra-forward thinking parents, some toddlers might be growing up on a gold mine.
Picture the scene at playgroup. Mum 1 says, ‘Of course, we’ve reserved a school place for little Lutetia already.’ Mum 2 smiles sweetly. ‘We’ve bought a flat in Oxford for when darling Tristram goes there.’ Modern Dad clears his throat. ‘Yesterday we, er, opened a pension plan for Tom.’ Silence. ‘I’ll get my coat.’
For many new parents it will sound ludicrous: planning your child’s retirement income before they’re even on solid food. It’s painful enough to imagine your bundle of joy becoming a surly teenager, so to picture them as a pensioner is more than most of us can bear. But what about a wealthy pensioner – even a pension millionaire? That’s a little easier to swallow. And thanks to the marvels of compound interest, relatively small pension contributions can result in a final pot that some far richer people might envy.
You can pay a maximum of £2,880 per year into a self-invested personal pension for a child, which becomes £3,600 through tax relief. Of course that means forking out £240 a month, which isn’t practicable for a lot of new parents. But even if the monthly payment is just £50, and all contributions stop when the child reaches 18, compound interest at 5 per cent should still grow the fund to more than £200,000 by the time the holder is 65. Now let’s suppose that the parents can afford the £240 a month, just until little Tom reaches 18. Even if Tom never makes another contribution for the rest of his life, his final pension pot should still end up being over a million pounds. Given that he probably will want to keep paying into it, the actual final size of his pension may be left to the imagination.
You may still wonder about the benefits of this – you’re unlikely to be around when your son or daughter starts to draw on their stash, and you’d rather help them financially when they’re younger. But in effect, you would be. If your children know that they have a decent pension plan in place already, they should have more spending power for other things. So by paying into a SIPP while your child is growing up, you could be indirectly helping them to buy their first property (for instance).
A smarter way to leave a legacy
There’s yet another advantage to setting up a pension plan for a child (or indeed grandchild). Those looking to pass on assets to subsequent generations should think carefully about inheritance tax. You can of course give lifetime gifts to reduce the value of your estate, but anything over £3,000 in a year will be taxed if you die within seven years of making it.
A gift under £3,000 may not seem very much – but as a pension contribution it’s another matter. If you wanted to pay into a grandchild’s SIPP, for example, you could pay the annual maximum of £2,880 and stay comfortably within the tax-free gift limits, while your gift would become £3,600 through tax relief. So you are not only creating a wonderful nest egg for the child’s future, but also reducing the size of your taxable estate (so you can pass on more to your own children). That’s two high-value pieces of tax planning in one.
It just goes to show that, when it comes to financial planning, there’s no such thing as looking too far ahead.
To find out if your own retirement savings could be doing better, why not book a free pension check? You can find participating advisers here, and there’s also £50 off any follow-up advice.
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