How to give your child a £1.5m pension

...thanks to compound interest, hailed by Einstein as the most powerful force of all

STARTING early can make all the difference when building wealth on behalf of children.

According to Gemma Godfrey, of online investment service Moola, ‘the hardest step is the first, but it is also the most powerful’.

A lot of the benefit from saving or investing early is down to plain and simple compounding, hailed by Einstein as the ‘most powerful force in the universe’.

This is where interest is allowed to accumulate over time, earning interest upon interest, helping build a savings pot. The same compounding effect works with income from equities where it is reinvested rather than taken.

Godfrey adds: ‘The sooner you start, the smaller the sums you will need to squirrel away. Plus, it gives more time to recover from any investment mishaps.’

Here’s how to begin building a future fortune.

GET TAX RELIEF ON A PENSION

YOUNGSTERS may not be overjoyed to receive a pension as a gift considering it remains under lock and key until they reach at least age 55.

But for better-off families it could be the perfect gift that goes on giving for a lifetime.

Rules allow relatives to salt away up to £2,880 a year in a pension for a child and have it topped up with tax relief to £3,600. Starting one for a new born would cost about £52,000 over 18 years – with a Government contribution top-up of nearly £13,000.

Jason Hollands, of wealth manager Tilney, says: ‘Assuming investment growth of 6 per cent a year until the child reaches age 60, they could end up with a pension worth nearly £1.5 million.’

With pensions, parents can afford to pick more adventurous investment options such as emerging markets.

Hollands adds: ‘Generally, with a pension for a child, I suggest investing globally through international funds such as Scottish Mortgage and F&C.’

OPEN AN INDIVIDUAL SAVINGS ACCOUNT

THE first port of call for most parents is a Junior Individual Savings Account (Jisa).

This is a tax-free ‘wrapper’ that protects cash savings or investments from income and capital gains tax. It cannot be accessed until a child reaches age 18. It is attractive because any savings held outside a tax-free wrapper on behalf of a child that earn annual income in excess of £100 in interest (or dividends) will be taxed as if it belongs to the parents.

The annual Jisa allowance is £4,260 in the current tax year. For more flexibility, a parent might prefer to open their own adult Isa and simply earmark the proceeds for their children. Isas for adults have a more generous annual limit of £20,000 and withdrawals can be made at any time.

TEACH THEM HOW TO SAVE CASH

CASH savings are crucial, providing children with hands-on experience of managing their own finances as they grow up. The bestbuy rates on standard savings accounts for children are available from HSBC (2.96 per cent), Nationwide Building Society (2.5 per cent) and Skipton Building Society (2.25 per cent). They can usually be opened from birth and operated by a child from age seven.

Cash Jisas offer higher interest rates than children’s savings accounts – but the drawback is that they cannot be touched until age 18. Financial scrutineer Moneyfacts says best rates are from Coventry Building Society (3.6 per cent), Danske Bank (3.45 per cent) and Darlington Building Society (3.25 per cent).

BUILD UP A STOCKS AND SHARES FUND

SINCE money in Jisas is locked away for up to 18 years, they are an ideal home for equity investments with their greater potential for inflation beating long-term growth.

Jonathan Raymond, of wealth manager Quilter Cheviot, is just about to open a Jisa for son George who is four weeks old. He says: ‘I am using cash gifts from grandparents to set up a stocks and shares Junior Isa for him.’ He will be choosing a suitable equity investment. He says: ‘Although cash is important, paltry interest rates mean you really need to engage in the financial markets to build wealth.’

Like many experts, Raymond favours investment funds and investment trusts for Jisas as they spread the risk for investors across a range of shares.

Most parents naturally gravitate towards the UK stock market as their starting point. But looking further afield to global markets may be more profitable.

Raymond says: ‘The FTSE AllShare Index is up 175 per cent over the last ten years but the FTSE World Index is up 280 per cent.’

More adventurous parents might tiptoe into even riskier territory, such as smaller companies which often perform better than larger counterparts over the long term.

Raymond likes Monks Investment Trust, a listed company that invests in international shares including Prudential and Google. For smaller companies exposure, he suggests investment trust River and Mercantile UK Microcap. For the UK, he likes Liontrust UK Growth which buys British-listed companies with a strong global presence, such as Diageo, Compass and Rolex.

He also recommends Smithson, a new smaller companies global investment trust launched by City legend Terry Smith.

Sarah Coles, of broker Hargreaves Lansdown, suggests parents can pique their children’s interest by selecting funds that include the shares of companies they are familiar with.

She says: ‘Scottish Mortgage Investment Trust holds familiar brands such as Amazon, Alibaba, Airbnb and Ferrari. Rathbone Global Opportunities invests in Activision Blizzards, the makers of Candy Crush Saga and Skylanders. Lindsell Train Global Equity holds Pepsico – owner of Pepsi and Doritos – as well as Disney.’

SET UP A TRUST FOR REGULAR SAVINGS

MANY investment trusts offer regular savings schemes aimed at children. Minimum contributions are as low as £25. For parents, the best strategy is to set up a simple ‘bare trust’. This means the child becomes the legal owner and receives the proceeds at age 18. It can be done when setting up the investment and is usually free.

TAKE A GAMBLE ON PREMIUM BONDS

WITH Christmas around the corner it could be tempting to buy a child a fun financial gift in the form of National Savings & Investments Premium Bonds. More than 800,000 under-16s currently hold them and this month alone 45,000 prizes were paid out to lucky youngsters.

As many as ten under-16s have even won the jackpot since 1994 when the first £1million prize was introduced. But there is no guarantee holders will win anything.

The odds of any £1 bond winning the jackpot is a distant one in 39 billion. The chance of a smaller windfall (at least £25) is a more appealing 1 in 24,500.

Currently only parents and grandparents can buy the bonds for kids with the minimum initial purchase set at £100 – or £50 by electronic transfer.