Gifting to our children or grandchildren is an excellent way to set them up for a brighter future whilst simultaneously mitigating your inheritance tax bill. There are a number of ways in which we can do this:
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Directly gifting cash – this allows immediate access and freedom for the recipient, which could be either a perk or a downside depending on their age and attitude
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Setting up a trust – You retain some control over the gifted monies, but the structure can be complicated and/or expensive
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Junior ISA – a very tax-efficient method, but full access and control is granted at age 18.
This list is by no means complete, particularly as it excludes one option which often flies under the radar – the Junior Pension. As you might expect, just like a Junior ISA the Junior Pension (also known as a Junior SIPP) can be opened by anyone on behalf of a young person under age 18 (provided an adult with parental responsibility for the child has consented) and contributions can be paid each year on their behalf to start building up a pension pot.
What are the Benefits?
Junior Pensions are powerful accounts for investing over the very-long-term, and you might consider opening one for the following reasons:
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Junior Pensions can accept contributions of £2,880 in each tax year, and the account will receive the usual 20% tax relief on top of this (or potentially even higher if the grandchild has additional income, e.g. taxable income from trusts). This means the government will add up to £720 in tax relief each regardless of whether the young person pays income tax or not, achieving £3,600 per annum. If paid regularly out of excess income this might also have immediate inheritance tax benefits.
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Junior Pensions cannot be accessed until the normal pension age is reached (currently age 57). This means it can grow uninterrupted and tax-free (just like normal pensions) over the child’s lifetime to provide a generous retirement pot for them, with no concerns about them accessing the money too early or spending it frivolously.
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As they pass age 18 the young person can choose to continue to pay into this pension if they wish, which often starts them in building good financial habits early on in life.
And the Drawbacks?
Despite the above benefits, some features of Junior Pensions may make them less appealing or unsuitable in some situations:
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The money cannot be withdrawn early unless as a result of ill-health, meaning it cannot be used for a house deposit or to purchase a car. These are often the most common reasons for gifting to young people, especially as the cost of housing continues to climb.
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The £2,880 annual limit is per child, meaning the opportunity to save in this manner is somewhat limited if several family members wish to contribute.
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As it is invested for the very-long-term making good investment choices will be paramount, since the impact of performance and charges will be amplified over 60+ years of compounding.
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Finally, often when we gift to our children we would like to witness them enjoying it, but with such a long timeframe before they can access it, this is unlikely to happen in most cases.
In numbers
To contribute the maximum annual sum to a Junior Pension takes a monthly payment of £240, equating to £2,880 paid per year with added tax relief of £720 on top. Over 18 years this amounts to a personal contribution of £51,840 and tax relief of £12,960. If your child or grandchild then retires at 65, having made no payments themselves, all these years of compounded investment growth may result in a pension value of:
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£101,277 by age 18
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£1,003,243 by age 65
Therefore, assuming reasonable investment returns* over 65 years, your child could witness the building of a million-pound nest egg whilst they themselves grow, work, and ultimately retire.
If it’s too good to be true…
A contribution of £51,840 turning into just over £1m is almost a 20x return, which shows just how powerful long-term compounding can be on an investment. That said, inflation will erode the value of this £1,003,243 over time, meaning the purchasing power will be materially lower in 2089 than it is today. If we assume inflation averages 2% over the next 65 years then the real value of the £1m will be approximately £338,171.
Although it is unlikely this will be enough to support someone through retirement into the 22nd century on its own, it still provides a huge head start to your (now not so) young one’s retirement planning and reduces the burden of saving over their lifetime.
Don’t have all your (nest) eggs in one basket
As with all investments and financial planning, diversification is key. By using a mixture of direct gifting, Junior ISAs, Junior Pensions and even trusts you can ensure you maximise the benefit and options for your children/grandchildren whilst mitigating the drawbacks.
If you would like some help, guidance or advice on how best to provide support and a legacy to your loved ones, then contact us via email or telephone and we would be pleased to talk it through with you.
*Assumptions used are:
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Annual growth rate of 5.0%
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Net contributions of £2,880 each year from birth until age 18, and none thereafter.
