Whitehaven News

A pension for your baby?

By Derek Baty, of Armstrong Watson

Last updated at 08:53, Monday, 31 March 2008

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Building for the future: It is estimated that a contribution of £2,880 made each year from birth until your child reaches 18 could produce a pension fund of approximately £1,310,000 at 60

When I was a child making contributions to a personal pension plan was certainly not high on my list of things to do with my pocket money – even if I could have afforded it!

However, times have moved on and since the introduction of Stakeholder Pensions in 2001 anyone can contribute up to £3,600 per year to a scheme regardless of whether they have earnings or not.

Now I’m not suggesting that you encourage your children to pay their pocket money into a pension plan, but parents, or perhaps more likely grandparents, can make contributions on behalf of the child.

This could help to reduce any inheritance tax liability at the same time.

The main advantage of paying a pension contribution on behalf of a child is that the payment is made net of basic rate tax, soon to be 20 per cent.

Your pension company will then claim tax relief from HM Revenue and Customs.

The effect of this is that from April 6 a £3,600 pension contribution will only cost £2,880 – producing an instant profit of 25 per cent. I think you’ll find it difficult to match that level of return from any other investment.

One point to bear in mind here is that even if the person contributing to the child’s pension fund is a higher-rate taxpayer, tax relief is still restricted to the basic rate.

It is estimated (based upon seven per cent per year investment return) that a contribution of £2,880 made each year from birth until the child reaches 18 would produce a pension fund of approximately £1,310,000 at the age of 60.

In contrast, if contributions did not start until he or she had reached 30, the fund would only be worth £298,000.

Another advantage of saving via a personal pension is that the fund grows largely free of income tax and completely free of capital gains tax.

However due to the ‘generous’ tax advantages provided by the Government, restrictions are placed upon how the accumulated funds can be accessed. These restrictions mean that a maximum of 25 per cent of the fund can be taken as a tax-free lump sum and the rest used to provide an income for life.

Current legislation also restricts access to the benefits before the age of 55.

If we look at the example above where £2,880 grows to £1,310,000 at 60 – the total net cost would be £2,880 x 18 = £51,840. 25 per cent of the fund would be £327,500 giving a profit of £275,660 and a free pension for life.

Clearly we are talking about a very long term commitment but the figures provide a compelling argument.