Jasmine Birtles
Your money-making expert. Financial journalist, TV and radio personality.
Pensions for Babies: Tax-Efficient Inheritance!
Lucy Miller
16th Oct 2024
Saving for a pension might be something that you only associate with those of working age, pulling in a salary at the end of every month. That’s not the only way that pensions work, though. In fact, parents are very able to invest in a pension fund for their babies, which can reap lots of rewards later on. If you’re looking for a tax-efficient inheritance plan for your kids, this might be the way forward.
So, what do you need to know about pension plans for babies? Here, we’ve pulled together some information on how you can make the most of this extremely tax-efficient inheritance method…
When should I open a tax-efficient inheritance pot for my child?
How much can I put into the fund?
When can my child access the pension fund?
Is there anything else that I should be aware of?
When should I open a tax-efficient inheritance pot for my child?
You can open a pension for a baby from the day they’re born. But of course, you don’t have to – in fact, you can start saving for your child’s pension pot at any time. Like with any savings plan, the earlier you start the more you’ll save (and the more interest you’re likely to earn).
(It’s not strictly the same as what we’re talking about here, but this article details the benefits of paying into your children’s pension pots even if they’re adults. Check it out if your kids aren’t babies anymore, but you still want a tax-efficient way of helping them out financially!)
Paying into your child’s pension is an ideal way to slash their inheritance tax bill on your estate, too. Unlike money held in a bank account, the savings in their pension are theirs alone. You’re gifting them the money early on – and can also pay into a Junior ISA AND gift up to a certain limit every year on top of that. It’s a far more tax-efficient way of handling your estate if you’re worried about inheritance tax rules.
How much can I put into the fund?
You can put up to £2880 a year into your child’s pension plan, making this a very tax-efficient way of saving for their future.
While children don’t pay tax, they still get tax relief – so if you fulfill the £2880 allowance each year, they get an extra £720 of tax relief on top. Just call it tax efficiency!
So, if you pay in the full amount every year until your child is 18, you could save at least £64,800 for your child’s pension! (Assuming the amount and tax relief remain the same – it’s likely the limits will increase over time, too). Even if they didn’t pay anything else into their pension from the age of 18, thanks to compound interest they’ll get a comfortable retirement fund. Assuming a modest interest rate of 2% a year, compound interest would turn the £64,800 fund into a retirement egg worth over £137,000. If average returns are better than that – let’s say 4%, the figure would be closer to £280,000.
When can my child access the pension fund?
The pension will transfer into your child’s ownership at the age of 18, but that doesn’t mean you need to worry about your teenager frittering away your hard-saved cash during their first few weeks at uni. In fact, even though it’s in their control it’s almost certain that they won’t be able to access it.
Like is the case with most pensions, your child won’t be able to access the fund until they’re at least 55. This might seem like it’s a long time away, but remember that this is exactly why you’ve set up a fund in this way. It’s designed to give them security when they’ve finished their working life, not to help boost their travel plans in their 20s or with a mortgage deposit in their 30s.
Double check this with the provider though, as you would any other details. There’s a chance that different providers have different rules, and that yours might allow you or your child to withdraw funds earlier.
What are the benefits?
There are lots of benefits to saving for your child’s future in this way. Here are the main ones:
- It’s tax efficient, as we’ve already talked about
- It can free up capital earlier in their life, as they’ll be able to lower the pension contribution that comes from their salary if they’re on a low income or in an unstable career area
- It’s easy to set up via a monthly direct debit, and you can forget about it like you would any other pension pot (although not completely – and remember to keep all your documents somewhere safe!)
- You’ll have full control over your contributions, so you can top them up whenever you like
- It could reduce your own inheritance tax bill, as you’re gifting money to your child (you can read more about how paying into your children’s pension could reduce your inheritance tax bill here)
- Pension pots for babies and children are provided by trusted companies too, with financial organisations like Virgin Money offering products, so you have the guarantees and security that these big names provide behind you
- Grandparents or other family members can contribute too, meaning the pot could grow with more than just your own investment (though the cap of £2800 applies)
- It can introduce your child to the concept of long-term saving, which is only ever going to be a good thing for their future financial literacy
Is there anything else that I should be aware of?
There are a few things to think about if you’re going to get the best out of your investment – here are the main ones…
Protecting the pension pot in the future
It might seem far away, especially if you’re setting up a tax-efficient inheritance scheme like this for a newborn. But once your children grow up and start thinking about marriage or cohabitation, you will want to think about their pension pot alongside any other assets that they might have acquired.
For this reason, before your child gets married they should arrange a prenup or a financial agreement that protects their pension. This alleviates the chances of half of your investment being lost in the case of a divorce.
The changing value of investments
Like with any pension (or indeed, any investment) the value of what you save can go up or down. This could mean that your child gets back less, or in some cases more, than you invest. Look at the risks associated with the particular pension pot you’re signing your child up to, and pick a low risk option to avoid this. You’ll find that the main providers have a few different options, so you can pick the best one for you and your family.
We hope this article has given you some insight into what benefits setting up a tax-efficient inheritance plan for your child (or children) can have.
Have you set up a pension pot for your child? How did it go? We’d love to know how you’re getting on with it – hop on to our MoneyMagpie Messageboard to chat to other Magpies about your children’s savings plans!
Now read:
- Easy ways to make your children rich (in the future)
- Investment ideas for availing tax benefits
- What is a LISA and should I get one?
- Protecting your property assets with a pre-nup
- Make over £133,000 with a Junior ISA
*This is not financial or investment advice. Remember to do your own research and speak to a professional advisor before parting with any money.
I am reviewing my own pensions at the moment. That’s what attracted me to read this article.
Good article, not many think pension for babies.