A few weeks ago, one of our articles highlighted how much young people are finding it difficult to set aside money for retirement. While pensions have always been a ‘hard sell’ to those who struggle to imagine themselves getting older and retiring, we recognise that flat wages, job uncertainty, high rents and the increased cost of higher education are all contributing factors that understandably leave younger people with less savings to set aside. And we also realise that a lack of pension could potentially have a disastrous effect on their long-term wealth as they get older.
This struck a chord with our readers, particularly those who have sizeable retirement pots themselves having paid into their own pensions over their lifetime, and perhaps benefitted from generous final salary schemes, as well as owning their own properties. So, it was encouraging to hear that so many of our clients are interested in helping their grandchildren with their finances and are considering setting up a pension on their behalf.
Setting up a pension for a grandchild
Pensions are considered individual investments and as such come with certain rules around how much can be invested and when. Most people are unaware of how the pension rules apply to family members, but in essence, a pension can be opened on a child’s behalf by their parent or legal guardian, and grandparents can then make lump sum contributions into the pension, quickly and easily as a “third party” contribution.
At present, the maximum amount you can invest into a child’s pension is £3,600, per tax year. But as qualifying contributions made to pensions are eligible for 20% basic rate tax relief, this means that the net contribution only needs to be £2,880, and the UK Government will top-up the rest. If you have several grandchildren, you can invest £2,880 annually for each of them. From a grandparent’s perspective, gifts could fall within the annual gift exemption of £3,000 or possibly be classed as gifts out of surplus income. Otherwise, anything above this level could be a Potentially Exempt Transfer, and therefore some thought would need to be given to the potential Inheritance Tax consequences of making contributions to a number of grandchildren in any one tax year.
As a reminder, investments held in a pension grow free from UK income tax and capital gains tax, making them a tax-efficient choice for longer-term saving.
The benefits of starting early
Once the pension contributions have been made, that money can then be invested to help it grow. Investing over several decades means it makes sense to invest in higher-risk/higher reward investments that can grow over time as well as riding out those periods of stock market volatility.
Also, investing over long periods ensures the growth is continually reinvested, meaning that the pension will benefit from the “magic” of compound interest. For example, if you started paying into a grandchild’s pension from the year they were born and for every year until they turned 18, their pension pot could have reached the £1 million mark by the time they reach 65.
Different pension options
If you are considering using a pension to invest for your grandchildren, there are two different pension options to choose from: a stakeholder pension and a personal pension. Stakeholder pensions allow you to pay low minimum contributions (from £20) up to the maximum annual amount, and you can usually pay either via lump sums or regular payments. However, most stakeholder pensions offer limited choice when it comes to the funds you can invest in.
With a personal pension, you get to choose from a wider range of investments but could pay more in terms of fund charges and annual fees.
As with any pension, one of the biggest drawbacks is that the money invested cannot be accessed until the grandchild reaches the age of 55 at the earliest, and this is likely to rise to 57 or 58 depending on the timing of increases in the State Pension age. There is also a good chance that the pension rules will have changed by the time your grandchildren reach retirement. However, to give you a real-life example, retired long-standing clients of ours who are now enjoying retirement, started investing in pensions for their six grandchildren some 20 years ago. Their eldest grandchild has just graduated from university with her own pension fund worth in the region of £150,000. She thanked her grandparents for their foresight and generosity and could well retire at age 60 with a million pounds pension pot, without ever paying a penny into it herself!
If you are planning on leaving your grandchildren with enough money to use as a deposit to buy their first home, then you might want to consider alternative investment arrangements, such as a Junior ISA, where the money can be accessed when the grandchild turns 18. For grandchildren over the age of 18, a Lifetime ISA, where the money can be used for retirement savings, or as a deposit for their first home, could be an appropriate option to consider.
If you are interested in discussing pension arrangements with one of our experienced financial planners at FAS, please get in touch here.
This content is for information purposes only. It does not constitute investment advice or financial advice.