For those parents and grandparents forward-thinking and liquid enough to consider pension savings schemes for their children and grand children, emotive, tangible and ‘natural’ asset classes
could fit the bill.
Steve Latto explains how clients can use SIPPs to build their childrens’ futures.
Despite current economic pressures many parents and grandparents are continuing to prioritise the financial security of their children and grandchildren. With the abolition of Child Trust Funds parents are keen to benefit from any potential tax benefits that are available.When it comes to saving for a child’s future most parents will automatically look to savings accounts traditionally offered by banks or building societies.
It is probably fair to say that most people do not think of a pension when they think about saving for their child’s future. Many people point to the fact that your child will not be able to take an income from their pension until they are 55 compared to a Junior ISA that gives access at age 18. However, if a parent saves the maximum £3,600 even without any investment growth they would have accumulated £64,800 by the time their child turns 18. Even taking into account inflation many parents would worry about their child suddenly coming into such a small fortune.
Despite putting the money away for university fees or a deposit on their first home, the reality is that their children would be able to spend the money as they please. Statistics from the Department of Work and Pensions at the end of 2010 revealed that more than ten million people alive today will reach the age of 100 and receive a telegram from the King or Queen. Of the ten million people set to become centenarians, over three million are currently under the age of 16. Many of those under 16 are expected to live to 110 years of age. Assuming these individuals want to retire at 65 they may have to fund up to 45 years of retirement. Previous generations often did not live long enough to see their children reach retirement age but with improvements in life expectancy, more and more parents will see their children live into old age. The financial security of their children is unlikely to become less of a priority but, by this time, they may be less financially able to support them.
Taxax
Another worry for parents and grandparents is that their child or grandchildren’s inheritance will be eroded by tax. There can be inheritance tax advantages of contributing to a child’s pension. Currently an individual can pass on an estate worth up to £325,000 without any inheritance tax applying. If an estate – including any assets held in trust and gifts made within seven years of death – is more than the threshold, inheritance tax will be due at 40% on the amount over the current £325,000 limit. Despite the recent slowdown in the housing market, many properties in the UK are valued in excess of £325,000 meaning many individuals need to plan ahead to minimise their family’s inheritance tax liability.
Many individuals do not realise that they could mitigate their inheritance tax liability by making gifts to a child’s pension. Gifts made to a child’s pension have the potential to qualify for a number of inheritance tax exemptions, including:
- Gifts of up to £3,000 each tax year are exempt from inheritance tax – making a gift of £2,880 (the maximum net pension contribution) to a child or grandchild’s pension an ideal way of making use of this exemption
- Gifts of up to £250 to an individual in a tax year can qualify as inheritance tax exempt payments
- Regular gifts made from an individual’s net income can qualify as inheritance tax exempt payments.
If a parent or grandparent gifts any monies that are not covered by these exemptions IHT will only apply if the parent or grandparent dies within seven years of the gift being made. By setting up a pension for a child, a parent or grandparent can help them on the road to a comfortable retirement and vitally may encourage the saving habit that their children will continue once they become an adult. The tax benefits from an IHT perspective are useful but perhaps the biggest reason for saving for a child via a pension or SIPP is the tax relief that is available on contributions. Non-earners including children can contribute £3,600 gross per year to a pension.
This means a parent or grandparent could make a contribution of £2,880, which would be topped up by basic rate tax relief of 20% to £3,600. There is the option of spreading this payment across the year via a regular monthly contribution of £240. If a parent or grandparent is in the fortunate position to be able to save £3,600 a year and they are considering opening a Junior ISA they may wish to consider opening a Child SIPP account and splitting payments, safe in the knowledge that they are providing for the medium and long term security of a loved one.
Steve Latto is head of pensions at Alliance Trust