Updated 03 September 2020
For the truly patient parent, there’s a little-known trick for setting your child up for life – later life, that is. A Junior SIPP may offer the most affordable long-term route to a millionaire’s retirement for your daughter or son. Article by Nick Green.
Starting a pension for a newborn baby – it sounds ridiculous. And yet, believe it or not, baby pensions truly are a thing. Technically called Junior SIPPs (SIPP stands for ‘self-invested personal pension’), they are a way for parents, guardians or other relatives to set up long-term savings for a child, which that child can then access as an adult from the age of 55.
Locking money away for a minimum of 55 years may seem an extraordinary thing to do. So much can happen in the intervening period, the child themselves won’t appreciate it for several decades at least, and you may not even be around for them to (at long last) say thank-you. However, if you are, then it could be a very big and heartfelt ‘thank-you’ indeed.
What makes a Junior SIPP so special? On the face of it, nothing – it’s just an ordinary SIPP that you can open on behalf of someone under 18, with the added limitation that you can only pay into it £2,880 per year (the adult annual allowance is £40,000). The only real difference is that most people only start their first pension when they start working – usually in their early 20s. This pension then grows, via both contributions and compound interest, for the rest of their working life – around 40 to 45 years if they retire in their mid-sixties. Thanks to this very long period of growth, even modest monthly contributions can result in surprisingly large pension pots.
So what if you were to start a pension aged zero? This might add another 18 to 20 years’ growth and contributions to a pension, before its holder even starts work. This financial head start could have far-reaching consequences for a young person, ranging from having more disposable income while they are younger, to being able to retire with a very substantial pension pot indeed.
To see how this can work in practice, let’s do some quick sums. If you were to make the maximum annual contribution of £2,880 into a Junior SIPP, tax relief at 20 per cent would mean that a total of £3,600 goes into the pension each year.
This amount would be invested in a fund or number of funds, which would generate growth. This growth would vary (and in some years there may be no growth at all), but for the purposes of this calculation we’ll assume an average growth of 4 per cent per year.
Assuming that you pay in the maximum amount for 18 years, and that average growth stays at 4 per cent, then by the child’s 18th birthday the pension pot will be worth around £95,000. Now, even if no further payments are ever made into this pension pot, steady interest at 4 per cent would grow the pot to over £620,000 by the time the ‘child’ reaches the age of 65.
By today’s standards this would be a very substantial pension pot. However, inflation means that the cost of living tends to double every 20-30 years, so that £620k might buy roughly what a £200k pension would today. So what would you have to do to increase that pension pot to a full million?
Let’s say you (or more likely, your son / daughter) were to continue to pay into that pension after the age of 18. The annual cap of £2,880 is now lifted, so they could now pay in much more if they can afford it. However, let’s assume they can’t afford huge contributions. How would they reach that million-pound figure?
Assuming growth remains constant, it would now require just £180 per month paid into the pension, to result in a final pot size of £1 million. At just £2,160 a year, this is well within the means of most graduates entering work, especially when employer contributions are taken into account. Usually a worker would increase their contributions as their salary rises – but someone in this fortunate position would be able to put their increased income to other uses, such as saving for a home.
It becomes clear now that that benefits of early pension saving may be felt long before retirement, since it can free up income for people early on in their careers (because they know that a large part of their retirement saving is already taken care of).
The other remarkable detail is how much you would have made in interest. In total you and your child would have paid in £153,360 by the time they reach 65. So in total you would have earned over £840,000 in the form of compound interest and tax relief.
Despite such impressive figures, a Junior SIPP clearly isn’t for everyone. An annual contribution of £2,880 that can’t be accessed for many decades will be too big a commitment for most ordinary households, and you will probably favour other, shorter-term solutions when it comes to saving for your children. However, the concept of ‘pensions for babies’ does provide a dramatic demonstration of the power of compound interest, and an eye-opening case for starting a pension just as soon as you can. When it comes to pension saving, time really is money, so the more years you can build up your pot, the better.
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