One way of ensuring that you don’t leave it too late to save for a pension is to start the minute you are born. Jenny Lowe explains

Here’s a novel idea for anyone looking to buy a baby gift, for it seems that no child is complete without the gift du jour – a pension.

Up until 2001, when the government introduced stakeholder pensions which allowed people to save up to £3,600 a year in a pension even if they had no earnings, the whole notion of discussing pensions and children in the same sentence would have sounded ludicrous.

Before then, if a parent wanted to put some money away regularly to help build a nest egg for their offspring, they would have simply opened a savings account for them at the Post Office, bank or building society, or invested in a Child Trust Fund.

Child Pensions - Truly long-term investments

However, due to the potential returns on a child’s pension, many people are now taking these out for their kids to provide a far more financially lucrative option than what was previously available to them.

Grant Bather, spokesman at Virgin Money, explains, ‘With any savings plan the more you put in the more your child will get back at the end. But with pensions especially, even modest amounts saved now will make a big difference in later years.’

Studies have shown that, on average, a newborn baby receives gifts worth around £600. According to Virgin Money, by devoting just £50 a month from birth until the child turns 18, your child could have a healthy pension pot of £23,700 at that age, which will continue to grow until the pension matures at 65.

Pensions are regarded as being one of the most tax-efficient savings you can make and offer unrivalled incentives, a statement that is no less apparent when it comes to kids’ pensions. Because they aren’t taxpayers, you can contribute up to £3,600 per year and still get basic rate tax relief. Basically, this means that you pay £2,808 and the taxman will add £792.

Although the introduction of the stakeholder option permitted pension saving for children, there isn’t a rule saying that you have to plump for a stakeholder. ‘You can actually use any form of individual pension, whether it be a personal pension, a stakeholder or a SIPP,’ says Tom McPhail, head of research at Hargreaves Lansdown.

‘If you wanted a very simple solution you might choose to go for a stakeholder because it has a transparent charging structure, limited investment choice and is, all round, a very uncomplicated solution. If you want to be a little more creative you could use a SIPP and then the world is your oyster in terms of what you can invest money in.’

Options for child pensions

There is a number of forms that pension saving on behalf of a child can take, stakeholder being the most basic. This allows investments of as little as £20 per month and the annual management charge is capped at 1.5 per cent, falling to one per cent after ten years. Personal pensions, on the other hand, do not have capped charges and these can be as much as 2.5 per cent in most cases but they do have access to a much wider spectrum of investment options.

SIPPs are a third option and offer the greatest flexibility of all, allowing you to invest in pretty much anything you like, including shares, funds, gilt and even commercial property.

According to Francis Moore, managing director of European Pensions Management, around 50 SIPPs for children have been set up so far. He points out, ‘With a SIPP you have access to both active and passive management. Some may opt for a simple approach via tracker funds, and for those with a deeper understanding there is the option to take a more active role. It’s down to parental view and ability.’

Family units also have the option of combining all of their pension planning into one pot and those who combine their pension investments in a SIPP gain added flexibility as they can invest in assets way beyond the scope of an individual investor. Moore adds, ‘Because the pension is pooled, the costs are also more competitive.’

Children’s pensions also double up as a great way for grandparents – who are generally very aware of the importance of saving for retirement – to reduce their IHT liability by making monetary gifts.

Getting the strategy right

In deciding to invest in a pension for a child it is, of course, appropriate to consider a number of important issues when selecting the investment for the child. ‘The main areas for consideration, which apply to all the various investment alternatives, are the level of risk, tax efficiency – both for the parent and the child – and access,’ opines David Seaton, director of Rowanmoor Pensions.

‘Risk and potential return are directly related. The greater the risk undertaken, the greater the potential profit. The lower the risk the lower the potential profit. A big advantage of a pension for a child is the length of time that the contributions have to grow.’

Tom McPhail calculates that, ‘Assuming seven per cent investment growth and 0.8 per cent annual charges, an investment of £300 per month, made into a pension plan for 18 years from birth would be worth £1,428,028 at age 60 (at a cost of £64,800).’ He adds, ‘Compare this with the child starting investing £300 per month at age 18, and saving for the next 42 years. The fund would be worth just £648,000, even though the cost had increased to £151,200.’

But Neil Lovatt, of Scottish Friendly Assurance Society , argues that these figures can be quite misleading. He suggests that, based on a £5,000 annual contribution being exposed to a growth rate of 5.5 per cent and escalation of 2.5 per cent, ‘Assuming that you only invest for the first 18 years, if you avoid pensions and invest in other tax-free investment vehicles and then switched over to a pension when the child becomes a higher rate taxpayer, you could essentially have a pension pot of £3.8 million as opposed to £2.9 million if the child was locked into basic rate tax relief.’

He adds ‘If the child never becomes a higher rate taxpayer, which is, of course, possible, they will be in exactly the same position as they were, but at least this way they have some choices.’

A long time to wait

When it comes to pension saving for children, the main disadvantage with these vehicles, mostly from the child’s point of view, is that the money is locked away until they reach retirement age. This means that when the time comes for your offspring to head off into higher education or take that all important first step onto the housing ladder, there won’t necessarily be an additional pot to dip into.

On the positive side, however, because they have had a head start in retirement planning, they won’t have to work so hard later, particularly at times when pension contributions will be pushed to the back of the queue, as Francis Moore explains, ‘When you think of it in terms of life changes, if the child goes on to higher education he will have loans to pay off and at some point he will want to get on the housing ladder, all of which will push planning for retirement into third place.’

Many parents and grandparents are also happy to keep this money away from their child’s grasp for as long as possible so that it is not wasted on fancy sports cars or frittered away in the university bar.

But, as Neil Lovatt points out, there are other ways to keep those little mitts off that substantial pot that you have built up to provide for their future, such as putting investments in trust, without forsaking flexibility.

He says ‘I would argue that if you are investing on behalf of your kids, you have the option of a Child Trust Fund with a maximum annual investment allowance of £1,200, you can use a tax-exempt savings plan from friendly societies which is an extra £300 per year. And children can put their money directly into whole series of open-ended investment companies and you will not have any taxes on any gains that you make as long as they are under £9,000 per year.’

He adds, ‘All you have to do then is strategically drip the money into a pension at the right time. If you do that you will be no worse off, have much more flexibility and will still have all of the benefits of being tax free.’