What is the best way to invest for a (minor) child or grandchild?
This is a question that comes up a lot, whether the ultimate goal is for a future house purchase, secondary education costs, to supercharge retirement savings, or some other need (perhaps the donor’s own estate planning goals for example).
Two of the most popular (and tax efficient) options are Junior ISAs and Junior Pensions. In this week’s blog, I consider the rules for each, along with their relative merits and drawbacks.
Junior ISAs
Junior ISAs ‘JISAs’ were launched in 2011 to replace Child Trust Funds.
They work in a similar manner to adult ISAs:
· The current annual allowance is £9,000 per child, who must be under the age of 18 and living in the UK (or the child of an overseas Crown employee),
· A JISA can only be opened by the child’s parent or legal guardian, but can be paid into by others - grandparents, friends, etc.,
· Like adult ISAs, the JISA can be held in cash or invested in stocks & shares, and any subsequent income or gains are completely tax-free,
· If you already have a Child Trust Fund open for your child, you will need to transfer this to the JISA before contributing –you cannot have both,
· Crucially, the JISA can only be accessed once the child reaches age 18, not before. And it’s important to note here that the money belongs to the child – at age 18, they will have unrestricted access to the funds.
Expanding on the final point, I see highly polarised views on this.
Some are extremely reticent about their child being able to draw on a potentially sizeable pot of money at age 18, without any tax or restriction. Others believe that getting children involved in investment decisions at an early age is a good thing and can enhance their longer-term ‘relationship with money’.
Both are sound arguments – it’s completely personal. And JISAs provide scope to build a substantial and highly tax efficient ‘nest egg’.
Consider the following example:
Example
James sets up a JISA for his newborn son and contributes the maximum £9k a year between birth and age 18.The monies are invested in a portfolio of global equities, returning an average5% a year after costs.
By age 18, the portfolio would be worth c. £265k and would be fully ‘wrapped’ inside a now adult ISA, hence there would be no tax to pay on any of the investment profits.
The chart below illustrates the projected growth in the JISA’s value. Note the widening gap between the two lines (the money paid in vs the investment value) – this reflects the power of compounding over time, i.e. ‘earning profits on past profits’.
Disclaimer: The figures above are for illustrative purposes only and do not reflect actual investment returns, which are not guaranteed. Investments should be considered over the longer term and should fit in with your overall attitude to risk and financial circumstances. When investing, your capital is at risk. The value of your investment can go down as well as up, and you may get back less than you invested. Investments should be considered over the longer term and should fit in with your overall attitude to risk and financial circumstances. Tax rules can change, and Junior ISA benefits depend on individual circumstances.
Junior pensions
Alternatively, or in addition, you could establish a Junior Pension.
· The same eligibility rules apply as before – the child must be under the age of 18 and living in the UK (or the child of an overseas Crown employee). And the pension must be opened by a parent or legal guardian, but others can contribute to it,
· Generally speaking, you can currently contribute up to £3,600 gross per year,
· As with adult pensions, contributions qualifyfor income tax relief. Assuming you ‘max out’, you would actually pay in £2,880and the pension provider will then reclaim basic rate (20%) tax relief on thechild’s behalf, crediting the plan with £720,
· And like adult pensions, there is no tax to pay on underlying investment profits within the pension, but the money is inaccessible until Minimum Pension Age –currently 55 but set to increase to 57 by 2028, with further increases likely thereafter.
Generally speaking, pension contribution is the most tax efficient form of saving/investing, given the upfront tax relief and subsequent tax-free investment profits. The main drawback, however, is accessibility, or lack thereof. The funds cannot be touched until the child reaches Minimum Pension Age.
Albeit some (me included) would argue that this could be spun as a positive – you could give the child or grandchild a fantastic head start on the pension ladder, and the potential compounding effect over 50-60 years is phenomenal – see example below.
Example
James’ friend, Sayid, also has a new born child. He too is keen to build a nest egg for them, but with a focus on future retirement. He therefore opts to direct funds towards a pension and ‘let compounding do the work’ over a very long timeframe.
· He opens a new Junior Pension and contributes the maximum £3,600 gross (£2,880 net) each year between now and their 18thbirthday.
· I assume the same 5% investment return (net of costs) as previously.
The chart below shows the projected pension value over 60years (assumed Minimum Pension Age):
The above is quite compelling.
On a total investment of ‘just’ £51,840 (18 years x £2,880 net contributions), and assuming a 5% pa investment return, this would produce a pension worth £867k by the child’s 60th birthday, supercharged by several decades’ worth of compounding.
Of course, it’s important to note that this is expressed in nominal terms and doesn’t take into account inflation – £867k in 60 years’ time would not buy the same amount of goods as £867k today.
If we assume inflation averages2.5% a year, this would be equivalent to c. £197k in today’s money– still a very health ‘head start’ and over 5x higher than the average pension pot size in the UK, according to the latest figures from the Office for National Statistics (ONS) and PensionBee (as quoted in this Times article).
Disclaimer: A pension is a long-term investment, and funds are not normally accessible until 55 (rising to 57 from April 2028). When investing via a pension, your capital is at risk. The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Your pension income could also be affected by the interest rates at the time you take your benefits. Tax rules can change, and benefits depend on individual circumstances.
Conclusion
Junior ISAs and Junior Pensions offer scope to build sizeable ‘nest eggs’ in your children or grandchildren’s names, and in a highly tax efficient manner.
The key differentiator between the two is around access:
· Pension saving is more tax efficient given the upfront tax relief, however, this comes with a greater restriction on access –the monies cannot be touched until Minimum Pension Age, which is likely to be around 58-60. Albeit, as noted above, this could actually be spun as a positive, providing savings discipline and scope for a phenomenal compounding benefit,
· ISA saving is still highly tax efficient (no tax relief on contribution but tax-free profits and withdrawals). It too comes with restricted access but ‘only’ until age 18, at which point, the child will have unrestricted access to the monies.
Personally, I like a mix of the two.
