Cash: you don’t need to save a lot to make a huge difference
Saving for the future of a child or grandchild is difficult at the best of times, but with the cost of living soaring, it can easily seem impossible. However, you don’t need to save a lot to make a huge difference.
Free government money and the power of compounding investment returns can quickly boost whatever you can put aside.
Saving in a pension in the name of a child can be one of the most effective ways to make your money grow.
For starters, there’s a huge incentive to do so. You can save up to £2,880 per financial year in child pension, and the government will top it up with a generous 20% on top of what you save.
Everything you hid will then have decades to enjoy compounding returns. Let’s say you invest £2,880 when the child is born and that grows by 6% per year. By the time they can access it – 57 from 2028 – it would be worth £109,000 in today’s money.
If you could pay the maximum contributions each year thereafter, by the time the child was 18, you would have paid £51,840 and the state would have topped up a further £12,960.
But the power of the returns could mean the pot is worth around £116,000, assuming returns of 6% a year. Left invested with no further contributions, but continuing to grow at this rate, the pension would reach £1.48 million by the time the child turns 60.
There are downsides and other options you may want to consider – or alongside a pension. This could be frustrating for a child struggling with more immediate financial pressures such as college fees, knowing they have a lump sum that they cannot access.
Still, Helen Morrissey, an analyst at investment platform Hargreaves Lansdown, believes an early pension can help children with more immediate financial priorities. “Getting their financial planning off to a good start gives them the freedom to focus on other aspects of their finances,” she says.
“For example, they may be able to contribute more to a security deposit because they don’t feel obligated to make large pension contributions.”
Because they don’t have access to it until later in life, a child’s annuity can be seen in some ways as a cost-effective and tax-efficient way to pass on an inheritance.
What a Junior Isa can be worth at 18
A Junior Individual Savings Account (Jisa) is also a great way to save for children. Like an adult Isa, any investment returns or dividends earned are tax exempt.
The main difference is that the annual allowance for a Jisa is £9,000 (for adults it is £20,000). Additionally, the child cannot take control of the account until age 16, accessing the funds at age 18.
As with a pension, investment returns can help small contributions go a long way.
For example, £100 a month in a Junior Isa from when a child was born would be worth £38,700 by the time they turn 18, assuming an annual return on investment of 6%.
It would go a long way toward paying college fees or putting down a down payment on a first home.
If you’re in the enviable position of being able to invest the maximum £9,000 for 18 years, the child would have £290,000 by the time they could access it – again assuming an annual investment return of 6%. There are also cash versions of Junior Isas, which act much like a normal savings account, except that they are not accessible until the child is 18 years old.
Sarah Coles, savings expert at Hargreaves Lansdown, says: “Some parents prefer the certainty of money. But in the long run, a Jisa investment is worth considering. Over five to ten years or more, it has 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 seem reckless. But it usually pays off. That’s because there’s plenty of time — in the case of retirements, decades — to weather the stock market’s ups and downs.
Over long periods of time, stock markets generally rise. Most investment platforms offer Jisas stocks and shares and self-invested personal pensions that can be opened in a child’s name. Providers include AJ Bell, Bestinvest, Fidelity, Hargreaves Lansdown, Interactive Investor and Wealthify.
You can either choose the investments yourself or use one of the tools offered by the platforms to choose between their recommendations. If you’re not sure which investments to choose, you can start with a large, low-cost global fund that invests in companies around the world. This way you don’t have to decide whether you think, say, the US stock market will do better than the UK, or whether tech stocks are the future.
Invest in the future they want
When investing in a child’s future, a growing number of parents and grandparents are choosing to invest in the world they want their child to live in. For example, if you want your child to live in a world less dependent on fossil fuels, you can invest on their behalf in sustainability-focused funds.
If you value a job market where workers are treated fairly and companies operate with a sense of social conscience, you may wish to favor investments in so-called ESG funds – in other words that have stated objectives around key environmental, social and governance issues .
There are hundreds of ethical funds available, but as a flavor, Dzmitry Lipski, head of fund research at Interactive Investor, mentions two that could be part of a portfolio.
He says, “The Montanaro Better World Fund invests in approximately 50 small and medium-sized businesses that aim to help solve some of the world’s biggest challenges. It ensures that all companies in the portfolio have a positive impact and focuses on themes such as health, well-being and the green economy. The fund turned a £1,000 investment into £1,236 over three years.
Lipski’s second choice is to fund BMO Sustainable Universal MAP Growth. It seeks ESG-friendly companies around the world. With total annual fees of 0.35%, the fund is in the low cost segment of the market.
It launched in December 2019, so three-year return data is not available. However, it is down 10.8% this year, in a difficult period for the financial markets.
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. Rates on children’s accounts tend to be more generous than for adults.
Among the current best buys is HSBC’s MySavings account, paying 3.25% interest. You can open an account with £10 and the money is accessible whenever you want. The Saffron Building Society is currently paying three per cent on a one-year bond, with a minimum balance of £5. #Yet, with inflation at 9.4%, there isn’t a single savings account that comes close 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 of a new gadget or toy.
“But when it comes to longer-term goals, leaving cash in cash probably isn’t the wisest decision.”
Friends and relatives can also buy premium bonds for a child. They’re unlikely to be the best way to help a child build wealth because they don’t pay interest, but they’re unlikely to win a big jackpot. Anyone over 16 can buy premium bonds for a child, but you’ll need to appoint 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, like adults.
hold the reins
If you want to retain more control over the child’s savings, a simple trust may be an option. This is a legal arrangement which means that the investments are held for the benefit of the child, without him directly owning them.
They can be useful if you have already used up all of the Junior Isa allowance or if you think you want to access the money before the child turns 18.
There is no limit to the amount that can be saved in this type of arrangement.
Trust income is taxed as if it belonged to the child. As he is unlikely to work, the child will have the full personal allowance of £12,570 to play along with an annual dividend allowance of £2,000.
And finally… you can donate money
Nothing prevents a parent or grandparent from giving money as a gift to a child, but inheritance tax issues should be considered.
If you make a gift and do not survive for seven years, the gift is still 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. For example, you can give up to £3,000 a year without paying inheritance tax. If you are able to donate from your income rather than your savings, and without it affecting your lifestyle, you can give as much as you want.
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