PERSONAL ACCOUNT

Starting a pension for a child or grandchild could be a life-changing gift

When is it too soon to start saving for a pension? For a lucky few their pension pots start growing as soon as they are born. That’s because of a little-used tax relief that allows children under 18 to save toward a pension, usually with the help of far-sighted and generous parents or grandparents. The results can be life-changing – both in returns and through the lessons about money this teaches.

The maximum contribution to a childhood pension with tax relief is £2,880 a year, and the tax relief available is 20pc, meaning that the government will top up a maximum contribution to £3,600 a year. Because £2,880 is below the annual gift allowance, such contributions should not incur inheritance tax.

If maximum contributions are made every year up to the age of 18, £51,840 will have been topped up by a further £12,960 in tax relief. More to the point, with prudent investments and reasonable returns, compound interest will have begun to work its magic.

Pensions are not at present accessible until 55, an age limit that is set to rise to 58 by 2028 – and likely later by the time today’s newborns are heading for retirement. With at least 40 years to grow uninterrupted, so early an investment has the opportunity to become a considerable sum.

If we assume 4pc annual growth after fees and inflation, by age 18 the pot would already be worth £100,000: double the amount actually invested. With no further contributions, it would reach £480,000 by age 58.

Under today’s tax laws, 25pc of a pension pot can be withdrawn free of income tax, potentially giving the child £120,000 tax-free at retirement, plus another £360,000 in their pension, a sum currently worth £15,000 a year for the rest of their life taken as an annuity. Not bad for an investment of £50,000 over 18 years.

Childhood pensions can be remarkably good value, but there are a number of considerations that have prevented this kind of saving from becoming more popular. First of all, you have to consider the opportunities – and tax relief – foregone. If you are a higher rate taxpayer, for instance, then paying into your or your spouse’s pension could gain you 40pc tax relief, rather than the child pension’s 20pc. In such circumstances, taking half as much from the taxman is a much less tempting prospect.

Second, and even more worrying, saving into a childhood pension means the money is locked away for most of the child’s life. That addresses some of the concerns around Junior Isas and bare trusts, which children can access and spend as they wish from age 18. But while it protects the money from imprudent teenage splurges, it also means that the funds can’t assist genuine financial need in young adulthood – for, say, study at university or buying a house. That could be frustrating for the recipient.

Finally, pensions are heavily dependent on political risk. It is hard

Small sums saved in a childhood pension will grow over time