Using the tax breaks available for children it is possible to build an enviable nest egg for little ones.
Two-fifths of grandparents (42%) are saving for their grandchildren’s future, and during the last year have put away an average of £154 each – or £2.4 billion collectively, according to JP Morgan.
There are several different ways to save for youngsters.
Read our complete guide to giving money to grandchildren...
In the current tax year you can put £3,720 into a junior ISA for children born before September 2002 or after January 2011.
Like the adult version, there are two types of junior ISAs: cash accounts and stocks and shares accounts, which can hold a variety of investments including equities, unit trusts, bonds, gilts, open-ended investment companies and exchange traded funds.
However, advisers argue that parents should opt for a stocks and shares account for those investing when the child is young. Over 18 years these will almost certainly outperform cash, especially given current low interest rates and rising inflation.
However, a cash ISA might be appropriate for an older child if they will soon need access to the fund, for example, if they are 17 and expecting to use the money to help fund university costs.
Invest in a pension
Another alternative is a pension. It might seem an absurd concept but the argument and numbers are compelling.
Parents or other family members can invest in a self-invested personal pension (SIPP) for a child, up to a maximum of £3,600 a year – or £300 a month.
Thanks to the tax breaks that come with saving in a pension, this means actually investing £2,880 – or £240 a month - with the balance being automatically reclaimed from HM Revenue & Customs.
The benefit of compound growth over the long term is key. If you were to invest £300 a month into a SIPP for the first 18 years of a child’s life it would cost you £52,000. Assuming 7% growth and 1.5% in charges, at age 65 the ‘child’ would have a pension pot of £1.8 million. This assumes the child makes no further contributions themselves throughout their working life.
By comparison, if they started a pension for themselves at age 25 and invested £300 a month gross, it would cost them a total of £115,000 in contributions and it would build a fund of just £496,000.
Pensions are a tax-efficient way to invest, benefitting from tax relief on the contribution, tax-free growth and a tax-free lump sum at retirement.
There is no minimum age so a junior SIPP can be started the day the child is born. The pension fund is outside the estate for inheritance tax purposes so this could become a valuable exercise if you need to reduce the value of your estate.
How to reduce inheritance tax...
Children’s Bonds are available from government-backed NS&I.
There is no tax on the interest on this cash investment and the current 35th issue guarantees a rate of 2.5% over five years. The maximum investment is £3,000 per issue which means after five years you would have £3,394.22.
The bonds can be cashed early with a penalty equivalent of 90 day's interest but they should be viewed as a five year investment.
A parent, grandparents or even great grandparents can invest for anyone under 16 and they cannot be held beyond the child’s 21st birthday.
Read our guide to tax and gifting money to children...