Pocket Money Pension

December 1st, 2008

If you are a parent you may have thought about arranging some sort of savings plan for your child, but also wondered about the best environment for your savings.  This is not surprising as there are a range of savings and investment products that you could use for this purpose.

Many parents understandably have concerns about effecting savings accounts or investments in their child’s name, which the child will be able to access at age 18 and are therefore reticent about giving up control of the funds.   Since their introduction on 6th April 2001 one solution has been to contribute to a Stakeholder Pension Plan on behalf of your child.  The plan can be set up in their name, from birth and importantly they will receive tax relief on any contributions you make.  As pension benefits cannot be accessed until age 50 (rising to age 55 from 6th April 2010) you can also be confident that you will be building a nest egg for your child’s long-term financial security.  Many people leave saving for retirement until it is too late, or very expensive and you may therefore be able to give your child a significant head-start.

So what exactly are the details and what is the potential impact of starting saving early?

Despite a child having no earnings (and therefore paying no tax) contributions up to £2,880pa would receive basic rate tax relief at source (currently 20%) and this is claimed from HM Revenue & Customs by the pension scheme administrator.  This means a maximum net contribution of £2,880pa (or £240 per month) would be ‘grossed up’ to £3,600pa within the plan.

This may seem like a gimmick but it is important to consider the impact of saving £240 (net) per month for a new born child until they are 18.  Even if the child does not continue with any further contributions they would need to wait until age 55 before they could take their pension and would benefit from continued investment growth during this period

Based on this scenario and assuming the investment grew by 7% p.a this could result in an overall pension fund (after accounting for inflation over this period) of around £229,000*   Assuming the fund could be converted to an annuity at a rate of 6% this could provide a pension of £13,740pa.

Alternatively, the child could take £57,250 as a tax-free lump sum and (assuming the same annuity rate of 6%) the remaining fund could provide a pension of £10,305pa. In both scenarios this assumes that the child themselves makes no further contributions between ages 18 and 55.

Although setting up a stakeholder pension can have significant advantages you would need to consider that the child could not access the benefits from the plan until age 55 and even then would only be able to take 25% as a lump sum with the remainder having to be used to provide an income. It would therefore not be appropriate if the objective is to say pay for university fees, or provide a deposit for their first property.  In saying that, how many of us now later in life wish that our parents had had a similar opportunity to give our retirement planning a kick-start?

Even if your children are now adults you may also be surprised it is still possible for you to make pension contributions on their behalf.  If they are higher-rate taxpayers they could receive tax relief at up to 40% on the contributions you make.

In summary, a stakeholder pension is not the only route available should you be looking to put some money aside for your child.  If the objective is to provide your child with a lump sum for use earlier on in life then there are other options available to you, such as Unit Trusts, Child Trust Funds (for children born on or after 1 September 2002), and Child Savings Accounts.  It is important to remember that equity based investments do not have the same level of capital security as deposit based investments and you should therefore take advice on the best option for you.

The value of your investment and income from them can go down as well as up and you may not get back the full amount invested.  Levels and basis of and reliefs from taxation are subject to change and their value depends on the individual circumstances of the investor.

*Please note we have made the following assumptions when calculating this figure

-The child receives basic rate tax relief on the contributions you make
-The figures assume the total pension benefits accrued by the child does not exceed the lifetime allowance (this is currently £1.65m for tax year 2008/9)
-Inflation is 2.5% p.a
-The charges in respect of the stakeholder pension plan are the maximum permitted.  Currently this is 1.5% of the fund value during the first 10 years and 1% thereafter

*Please note we have made the following assumptions when calculating this figure

  • The child receives basic rate tax relief on the contributions you make

  • The figures assume the total pension benefits accrued by the child does not exceed the lifetime allowance (this is currently £1.65m for tax year 2008/9)

  • Inflation is 2.5% p.a

  • The charges in respect of the stakeholder pension plan are the maximum permitted. Currently this is 1.5% of the fund value during the first 10 years and 1% thereafter