Cash in hand: You don’t have to save a lot to make a huge difference
Saving for a child or grandchild’s future is hard at the best of times, but with the cost of living soaring it could easily feel impossible. However, you don’t have to save a lot to make a huge difference.
Free government cash and the power of compounding investment returns can quickly turbo-boost whatever you are able to put aside.
Saving into a pension on behalf of a child can be one of the most effective ways of making your money stretch further.
For a start, there is a massive incentive to do so. You can save up to £2,880 each financial year into a child’s pension, and the Government will top it up with a generous 20 per cent on top of what you save.
Whatever you have stashed away will then have decades to benefit from compounding returns. Let’s say you put in £2,880 when the child is born and that grew at six per cent a year. By the time they are able to access it – age 57 from 2028 – it would be worth £109,000 in today’s money.
If you were able to pay in the maximum contributions every year after that, by the time the child was 18, you would have paid in £51,840 and the state would have topped up by a further £12,960.
But the power of investment returns could mean that the pot is worth around £116,000, assuming returns of six per cent a year. Left invested without any further contributions, but continuing to grow at this rate, the pension would be worth £1.48million by the time the child is 60 years old.
There are downsides and other options you may wish to consider – or alongside a pension. It could be frustrating for a child struggling with more immediate financial pressures such as university costs, knowing that they have a lump sum they cannot access.
Yet Helen Morrissey, analyst at investment platform Hargreaves Lansdown, believes starting a pension early in life can help children with more immediate financial priorities. ‘Getting their financial planning off to a strong start gives them freedom to focus on other parts of their finances,’ she says.
‘For instance, they may be able to contribute more towards a house deposit because they don’t feel pressured to make large pension contributions.’
Because they only access it later in life, in some ways a pension for a child can be seen as a cost-effective and tax-effective way of passing on an inheritance.
What a Junior Isa can be worth at age 18
A junior Individual Savings Account (Jisa) is also a great way of saving for children. Like an adult Isa, any investment returns or dividends earned are tax free.
The key difference is that the annual allowance for a Jisa is £9,000 (for adults it is £20,000). Furthermore, the child can take control of the account only at age 16, accessing the funds at 18.
As with a pension, investment returns can help modest contributions go a long way.
For example, £100 a month into a Junior Isa from a child’s birth would be worth £38,700 by the time they reach 18, assuming annual investment returns of six per cent.
That would go a long way towards helping with university costs or a deposit on a first home.
If you are in the enviable position of being able to invest the £9,000 maximum for 18 years, the child would have £290,000 by the time they were able to access it – again assuming annual investment returns of six per cent. There are also cash versions of Junior Isas, which act much like a normal savings account except they can’t be accessed until the child hits 18.
Sarah Coles, savings expert at Hargreaves Lansdown, says: ‘Some parents prefer the certainty of cash. But over the long term, an investment Jisa is worth considering. Over five to ten years or more, it stands a better chance of beating inflation than cash.’
How to invest for a child
Taking a high level of investment risk with a child’s precious nest egg may feel reckless. But it usually pays off. This is because there is plenty of time – in the case of pensions, decades – to ride out the ups and downs of the stock market.
Over long time periods, stock markets usually rise. Most investment platforms offer stocks and shares Jisas and self-invested personal pensions that can be opened on behalf of a child. Providers include AJ Bell, Bestinvest, Fidelity, Hargreaves Lansdown, Interactive Investor and Wealthify.
You can either pick the investments yourself or use one of the tools that the platforms offer to choose between their recommendations.
If you’re not sure what investments to pick, you could start with a broad, low-cost global fund that invests in companies all around the world. That way, you don’t have to decide if you think, for example, that the US stock market will do better than the UK, or if technology stocks are the future.
Investing in the future they want
When investing for a child’s future, growing numbers of parents and grandparents are choosing to invest in the world they wish their child to live in. For example, if you want your child to live in a world less dependent on fossil fuels, you may wish to invest on their behalf in funds that focus on sustainability.
If you value a jobs market where workers are treated fairly and companies operate with a sense of social conscience, you may wish to prioritise investments in so-called ESG funds – in other words those that have stated aims around key environment, society and governance issues.
There are hundreds of ethical funds available, but as a flavour, Dzmitry Lipski, head of funds research at Interactive Investor, mentions two that could form part of a portfolio.
He says: ‘Montanaro Better World Fund invests in around 50 small and medium-sized companies that aim to help solve some of the world’s biggest challenges. It ensures that all companies in the portfolio are having a positive impact and it focuses on themes such as healthcare, wellbeing and the green economy.’ The fund has turned a £1,000 investment into £1,236 over three years.
Lipski’s second choice is fund BMO Sustainable Universal MAP Growth. It seeks out companies from around the world that are ESG friendly. With a total annual charge of 0.35 per cent, the fund is at the low-cost end of the market.
It was launched in December 2019, so three-year returns data is not available. However, it is down 10.8 per cent this year, in a difficult period for financial markets.
STEVE WEBB ANSWERS YOUR PENSION QUESTIONS
A savings account is another option
If you don’t want to invest a child’s money in the stock market, a children’s savings account is an alternative option. Rates on accounts for children tend to be more generous than for adults.
Among the current best buys is MySavings account from HSBC, paying 3.25 per cent interest. You can open an account with £10 and the money can be accessed whenever you like. Saffron Building Society currently pays three per cent on a one-year bond, with a minimum balance of £5. #Yet, with inflation running at 9.4 per cent, there is not a single savings account that gets near to beating it.
Amy Pethers, financial planner at wealth manager Brewin Dolphin, says: ‘Piggy banks and cash savings accounts are useful for teaching young children about money, as well as funding short-term goals such as buying a new gadget or toy.
‘But when it comes to longer-term goals, leaving money in cash probably isn’t the wisest decision.’
Friends and relatives can also buy Premium Bonds for a child. They are unlikely to be the best way to help a child grow their wealth as they do not pay interest, but there is slim chance that they could win a big prize.
Anyone over 16 can buy Premium Bonds for a child, but you will need to nominate a parent or guardian to look after the money until they turn 16. A child can have up to £50,000 of Premium Bonds in total – the same as adults.
Keep hold of the reins
If you wish to retain more control over the child’s savings, a bare trust may be an option. This is a legal arrangement that means investments are held for the benefit of the child, without them directly owning them.
They can be useful if you have already used the full Junior Isa allowance or if you think you may want to access the money before the child reaches the age of 18.
There is no limit on the amount that can be saved into this type of arrangement.
Income from the trust is taxed as if it belongs to the child. As they are unlikely to be working, the child will have the full personal allowance of £12,570 to play with, as well as an annual dividend allowance of £2,000.
And finally…you can give money away
There is nothing to stop a parent or grandparent handing over cash as a gift to a child, but inheritance tax issues need to be considered.
If you make a gift and do not survive for seven years, the gift remains part of your estate for inheritance tax purposes.
Inheritance tax is paid on estates worth more than £325,000 or £650,000 for a couple. There are also a number of allowances that could help you out.
For example, you can give away up to £3,000 a year with no inheritance tax to pay. If you are able to make gifts out of income rather than savings, and without it affecting your lifestyle, you can give away as much as you like.
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