Pension for Child?

mcooke999

I'll try and explain the thinking behind setting up my 1yo with a pension so you can see why I think it's such a good idea:


I don't really want to turn this thread into a discussion about my assumptions as each one could be argued until the cows come home, these are just what I think are sensible best guesses, others may/will disagree and that's fine.



Assumptions:
Initial Investment = £3,000 (i.e.: £3,750 including tax relief)
Monthly Contributions = £30 (i.e.: £37.50 per month including tax relief)

Contribute from age 0 until 21 only, then stop! (Obviously the child would be best carrying on but I will assume this does not occur)

7.5% total return on equities (dividends + capital growth)
4% return on bonds
2.5% inflation
Platform fees 0.15% (Vanguard, assuming they release their SIPP soon!)
Average fund OCF, say 0.15% for Vanguard index funds

Retirement age = 65y/o (likely to be higher in 65 years!)

Starting asset allocation at age 0 = 100% equities
Asset allocation at age 65 = 50% equities / 50% bonds
Working life salary = £28k (UK national average)
Salary during retirement = 66% working life salary i.e. £18.6k
State pension age = 68y/o (assuming this will still exist of course)

Contributions to rise in line with inflation
Required salary during retirement (£18.6k) to be adjusted in line with inflation to calculate required drawdown


Results:


Based on the above assumptions, using a spreadsheet I have created, the results are as follows:


Total contributions: £16k (ish)

Value of portfolio at retirement (65y/o): £704k, £135k when converted back to todays money.
Portfolio would then only run out at age 80.



Obviously the portfolio runs out too soon so in practice they would need to carry on contributing after age 21 but only £50 (ish) per month to ensure a comfortable retirement, not the £300 - 500+ they would need to if they start after age 30 or whatever.


I'd never let them think they didn't need to contribute themselves, this would simply be a very cost effective way of giving them a decent 'leg up' by utilising their age to harness compounding. They would always be taught the value of regular savings / sticking to a goal etc.

cloud_dog

Lots of reasonable assumptions and some (minor) mistakes.

Simple mistake, unless your child has some sort of other income the maximum you can contribute is £3600 gross.

As other posters have pointed out, there is nothing wrong in starting a pension for a child early per se.

The considerations most people have on the subject are:

1. Do I have sufficient disposable income to support this?
2. Have I exhausted all other avenues?
3. Would my child be financially better off if I were to keep the pension contributions for their benefit earlier in life, or to put in to a LISA (obtaining the 25% bonus; equivalent to the 20% tax relief)?
4. Can I maintain this should I have other children?
5. Am I likely to create a LTA issue further down the road?
6. Am I likely to remove the ability for my child to make additional contributions, were they to be a HRT, to reduce their tax and or receive other benefits (child benefit, share in partners income tax allowance)?
7. yada, yada, yada

So there's nothing incorrect or wrong in doing it but, is it really the best option for the child?

I thought about it, dismissed it, and am saving (investing) using both mine and my OH GIA. Come 18 we can look at helping with finance stuff (Uni etc), starting a LISA, etc or consider lump sum payments in to a pension (if appropriate) at that time. My opinion is that the child is likely to benefit far more by having the financial uplift earlier in life than later.

short_butt_sweet

mcooke999 wrote: »

Initial Investment = £3,000 (i.e.: £3,750 including tax relief)
Monthly Contributions = £30 (i.e.: £37.50 per month including tax relief)

a minor point: you can't quite do that initial investment on day 1, because the maximum contribution that attracts tax relief, for somebody with no earnings (including a 0-year-old) is £2,880 (i.e. £3,600 including tax relief). however, that's no big deal, since you could just postpone part of the initial investment until the following tax year.

but in terms of overall strategy (and i agree there's little point in debating your exact assumptions) ...

you are right that this could make a significant difference for your child. but i disagree that putting this money in a pension is the best approach. i think it is far more beneficial to keep it accessible sooner, so it can be used for (mostly obviously) a deposit on a house, or any other number of purposes.

(more accessible could mean in a JISA, if you don't fear giving your child full control of it at age 18; or otherwise in your own name(s), but regarding it as earmarked to help them at the appropriate time.)

am i suggesting throwing away the benefits of really long-term compounded returns, over 65+ years?

absolutely not. the money can (and should) be invested until it might be used (for house deposit, or whatever else). and pulling it out of investments, when buying a house, doesn't means giving up on compounded returns at that point: it means that your child starts to benefit from compounded growth in house prices, instead of their landlord benefiting from it while they can't buy until later because their money is tied up in a pension. if it gives them a bigger deposit rather than a smaller deposit, it means they benefit from a lower LTV and hence a lower mortgage rate, which gives them more cash to spare which they can invest (e.g. in a pension), where it will compound again.

compounding of returns always works, not just in a pension, provided you are doing something productive with your money, not just p*ssing it away. and if you're worried that's what your child will do, then really there is no fix for that, except for teaching them about using money better, and delaying giving them capital until they are more grown up.

also, the tax relief on pension contributions for a child, at 20%, is as unfavourable as it gets. you should look at matching employer pension contributions are being equivalent to tax relief. nowadays, most employees can get matching employer contributions. so in so far as it is a choice of pension contributions as a child, or when grown up and working, the latter is much more favourable. in the early years of working, it can be a bit of a dilemma whether to save up for a deposit, etc, or to take advantage of favourable tax relief / employer matching on pension contributions. you won't help with this by giving your child an initial pension pot. you will help if you give them some capital they can use as a deposit, which enables them to concentrate on taking full advantage of favourable terms for pension contributions from their earnings.

if you retain control of capital intended for a child, you could even use it as leverage to encourage (higher) pension contributions. sign up to (or don't opt out of) the pension, and we'll give you £X towards your house deposit!

also, long-term compounding works both ways. with compound returns, it works in your favour. with on-going charges, it works against you. and the charges on pensions are generally a little higher than charges on other investments (e.g. ISA). and that really bites over long periods. e.g. even an extra 0.1% in on-going charges (and it might be more than that), over 65 years, would reduce the size of the final pot by c. 6%. this tends to put me off using pensions for the super-long-term, unless they are otherwise clearly favourable.