A look at how you can save and invest for your children’s future.
A number of my friends have either recently given birth or announced that they are pregnant. This prompted me to wonder about the things that a parent can do to help their children financially in life.
As you read more about investing, you will eventually come across the following two quotes:
“Time in the market, not timing the market” – Warren Buffet
“Compound interest is the most powerful force in the universe” – Albert Einstein
And you’ll start to think to yourself, “Why couldn’t I have read about this years ago!? Why weren’t we ever taught about this at school!? I’ve missed out on years of gains already!”
One advantage your children will have over yourself is time. Let’s imagine that you are 30 years old and you simply stick £2,000 into an investment each year which grows by 3% above inflation. After 30 years, this will be worth £100,000. After another 30 years, this will be worth £340,000!
Clearly, the earlier you start investing, the better.
Conveniently, the UK currently offers two different products specifically for children under the age of 18 to help you save and invest for their future:
Junior SIPP
‘SIPP’ stands for Self-Invested Personal Pension.
In a typical SIPP, you can contribute 100% of your earnings before tax, up to a limit of £40,000 (for the tax year 2018-2019). If you earn more than £150,000, then the amount you can contribute is reduced. However, even if you don’t earn anything at all, you can still contribute £3,600 per year and get basic tax relief.
A Junior SIPP works in the same way; you can invest up to £3,600 gross per child per tax year. This includes the tax relief – in other words, you can pay in £2,880 and the government will pay in the 20% tax relief, up to £720.
When the child turns 18, the Junior SIPP automatically converts to an adult SIPP, and they can begin to make their own contributions.
Investments are free from UK income and capital gains tax, however, they are subject to tax on withdrawal. For example, if you withdraw £20,000 from your SIPP in one tax year year, then you will be taxed 20% on the amount above the personal allowance (currently £11,850 per year, but will presumably be much higher in 60 years!).
One important thing to remember is that any money put into a pension is locked up for a long time. At the moment, a SIPP cannot be accessed until age 55. This age is scheduled to increase to 57 from 2028, and is very likely to increase again in the future. During that time, rules regarding pensions may change.
The below chart attempts to show what your child could end up with if you invest the maximum of £2880 per year, topped up by basic tax relief from the government, and allowed to grow at a rate of 2%, 3% and 5% above inflation until they turn 60. The blue line shows the total contribution over the first 18 years. Obviously this is a gross simplification; no one knows what the future will bring, and investments are likely to decrease some years and stagnate during others.
Junior ISA
‘ISA’ stands for Individual Savings Account.
Junior ISAs work much like a normal ISA, only with a lower limit. In the 2018-2019 tax year, you can save up £20,000 in a normal ISA, whereas the savings limit for a Junior ISA is £4,620 per year. You can choose to keep the money in a cash ISA or a stocks and shares (S&S) ISA, or both.
The child can take control of the account at 16, but can’t withdraw from it until 18.
Just like a SIPP, interest on the money in a cash ISA, and capital growth or dividends in a S&S ISA, is tax free. However, unlike a SIPP, the money is also tax free on withdrawal.
Which one is best?
Obviously, the question of which product is best will be different for each child, and depends entirely on what your aims are for the money. If you’re saving up a deposit for your child’s first house, for driving lessons, or for university, then obviously an ISA would be more suitable. If, however, you are worried that your newly turned 18 year old child may not have the same discipline with money that you’ve cultivated over the years, then maybe a SIPP would be the better choice! They can’t access it until 57 (at least), and then it truly will have time to take full advantage of compound interest gains. Or, of course, you could open both.
2 replies on “Investing for your children”
I’d rather put the money into my own pension, I’d get better relief on it and will be able to take it out sooner. Then I could gift it to my child, or spend it if they’re naughty? 🙂
This would change of course if I was already maxing my own ISA and SIPP, I could use the extra allowance for them.
I did contemplate shoving £15k or whatever in a separate portfolio for each child I had and just letting it compound but then I realised that the money would compound just the same in my own account.
Haha, that is a very valid point! I didn’t consider this… A quick bit of research indicates that your children can inherit your pension tax-free, but, if you die over the age of 75, then they have to pay income tax on anything they withdraw. So I suppose there is still some advantage to saving something in a separate child’s account, as they will be able to withdraw up to the personal allowance before paying tax on the income. And of course, if you were able to max your ISA and SIPP and still had money to spare, then the junior ISA and junior SIPP come into their own. Having said that, who knows what changes future governments will introduce!
Another thing to consider is the lifetime allowance. If it’s looking likely that you’ll hit that allowance, then it makes sense to start investing in either your spouse’s or your children’s name in order to avoid that hefty tax.