Warr on...

That perennial question - What do you get the child that has everything this Christmas? A new bike perhaps? The new Apple iPhone? What about a pension? As strange as it sounds, it potentially makes a lot of sense because a pension is not just for Christmas but for life!

In our experience, many clients do not realise that they can contribute to a pension for a child. There are many different investments that you can consider for a child, each with their advantages and disadvantages. You can gain an insight into these by reading our section on Child Investment Planning.

We often convey to clients the benefit of a multi-dimensional approach to retirement planning. Why? Well one feature of a pension is that once money is invested, access is restricted until age 50 (age 55 post April 2010) is attained. This can be considered an upside or a downside, depending on your viewpoint. However, as far as succession planning goes, this could be perceived as a benefit.

When setting aside monies for a child’s future, clients may have in mind educational costs and property purchase as primary objectives. If, however, those have been planned for, or can be afforded out of current income or capital, then longer term planning may be a consideration, not only in regards to the child’s future well being but also in respect of a client’s own inheritance tax (IHT) planning.

An individual may contribute £3,600 per annum into a pension on behalf of a child or grandchild. Let us take as an example a client paying £3,600 per annum for a newborn child. Assuming an intermediate growth rate of 7% per annum, the accumulated fund after 20 years would be £146,000. Assuming at that point contributions ceased, the fund would roll up over the next 40 years to age 60 to a value of £1,700,000. This has been achieved from a total outlay of £72,000 gross or £56,160 net after basic rate tax of 22% has been deducted at source.

To illustrate the effect of this early start to their retirement planning, if instead nothing was done and the child was left to fund their own retirement planning, starting at age 20, contributions of £799 per month gross would need to be made in order to achieve the same end result. This equates to total net contributions of £299,145 (£383,520 gross). This demonstrates a substantial cost of delay, a subject that has already been touched on in the article Pensions New & Old - Contribution Limits.

This type of planning can be very tax efficient indeed. Not only does the contribution attract basic rate income tax relief at source for the donor, if such planning is undertaken for an older child who happens to be a higher rate income tax payer, a further 18% relief may be claimed by them. The contributions are invested in a very tax efficient fund, rolling up in an almost gross environment. With regards to IHT planning, such contributions may be made to utilise the annual exemption or, be made out of normal expenditure from income, which will have an immediate, beneficial impact with regards to reducing a client’s IHT position.

Undertaking retirement planning for a child may seem a little premature. However, this means that their own disposable income may be sensibly utilised for other purposes such as property purchase as a primary example.

Please feel free to contact ourselves if you would like to discuss any proposed pension and /or IHT planning.

(Source of quoted projected figures: AXA - November 2007)

These figures are for illustrative purposes only. The value of investments can go down as well as up and is not guaranteed. You could get back less than invested.

Date of Article: 3rd December 2007