Parents and relatives opened almost 1 million Junior ISA accounts in the 2017/18 as they looked to help get their children into good savings habits. Figures from the Office for National Statistics show that more than £850 million has been stashed into these accounts since they were launched in 2011 – but is this the best way to save for children?
Up to £4,260 can be invested through Junior ISAs in the current tax year, allowing relatives to kick start kids’ savings pots in a tax efficient way.
Ammo Kambo, chartered financial planner at Brewin Dolphin, says: “As a nation of savers, it is up to us to ensure the next generations has the tools and mindset to make their money work harder.”
At age 16, children take control of these accounts and are able to decide where the money is saved or invested. At age 18, they are able to access the cash. This is the stage that concerns many parents, who are worried that their children might blow the cash they have so carefully squirrelled away for them. And this is why many relatives might do better to open a children’s pension instead.
Starting a pension for a young person might feel a bit premature but it offers many of the same benefits as Junior ISAs: a tax-free way to invest for the long-term and start to build a savings pot for young relatives.
Just as with adult pensions, money saved is subject to tax relief – even though children are most likely not paying any tax themselves – so the maximum of £2,880 saved in a tax year is topped up by 20% to £3,600 by the government.
Crucially, the money cannot be accessed for decades – currently personal pensions can be accessed at age 55 but this is rising. Not only does that mean peace of mind for panicking parents, it means the cash can benefit from the effect of compound interest over the long-term.
If the maximum amount of £3,600 was saved each year and grew at an annual rate of 5%, by the time the child reached age 18 their pension pot would be worth almost £104,000.
If the money continued growing at the same rate, even if not another penny was added to the pot, the pension would grow to a hefty £632,460 by the time they reached age 55. Currently, that would buy a single 65-year-old man an annuity of £33,725 a year, according to the Aviva annuity calculator.
Beware the Lifetime Allowance
But Michael Martin, private client manager at Seven Investment Management, says this brings its own problems: “While saving into a child’s pension is a sensible and very nice thing to do you may be inadvertently causing them a lifetime allowance issue.”
He points out that having so much saved already, means the young person will have to carefully monitor any future contributions of their own that they make to a pension scheme. “It could be that they end up paying far more in tax than they would otherwise or missing out on workplace pension contributions as a result,” he adds.
There are other considerations to bear in mind, too. Having a large pension pot already saved for them could deter a young person from starting a savings habit of their own. As well as that the parent or grandparent is unlikely to live long enough to see their young relative enjoy the money they have so carefully saved for them.
Kambo adds: “There are many things to consider, but the financial goal at the outset is often the first sensible step. Each option serves a purpose and the final decision should be based on what you want the child to do with the money once they can access it. A child pension might offer more financial freedom in retirement, but it’s not the best option if you want the child to be able to pay for university tuition fees or a deposit for their first home.”
Relatives who would like the money to be used in this way may also be fretting about Junior ISAs without cause. Research from AJ Bell reveals that just 7% of Junior ISA customers cash in their accounts when they reach age 18. Anecdotal evidence suggests that if children are involved in the savings journey and aware of their pot, they are less likely to squander it.
It is worth bearing in mind, too, that there are more options to choose from than simply pensions or JISAs. Inheritance tax allowances, for example, allow up to £2,500 to be gifted to relatives each tax year. Martin adds: “You might also be better putting money into a life assurance plan, which pays out on your death. This way the child gets a tax-free lump sum and it doesn’t affect their lifetime allowance.”
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