Pensions  

Danger of children's pensions laid bare

Danger of children's pensions laid bare

A financial adviser has warned about the impact of parents putting their money into children's pensions, as these "are unsuitable for all but the wealthiest families".

David Hearne, chartered financial planner and director of Satis Asset Management, told FTAdviser he is "concerned that while pensions appeal to the emotional side of parents and the responsibility they feel to their children, that they are not necessarily in the best interest of their children or themselves".

According to the current rules, parents can pay £2,880 a year into their child's pension, which can take the form of a self-invested personal pension (Sipp), or a stakeholder pension, among other types.

The child will benefit from 20 per cent tax relief on top of this, taking the total to £3,600.

However, the money will be tied up until the child is in their late fifties.

Mr Hearne said: "Parents do not need to save in a pension wrapper to get the benefit of compound growth.

"They could use their own Isa allowances, and then gift the money to their children later, either to be paid into their pension, or perhaps to buy a house, repay student debt, or start a business - all of which might have more impact to their children’s lives, but all of which are unknown when you contribute their pension as a child.

"The idea that a 25-year-old is unable to save a deposit to buy a house, but has £50,000 in a pension they can't access, could be hugely frustrating for them, and their parents, when they thought they were helping their children's future by starting a pension for them."

Mr Hearne also noted that the tax relief children receive in their pensions is "often billed as free money, but it is not free, because under current rules 75 per cent of withdrawals from the pension will be taxable".

He identified two ways in which parents could inadvertently hurt their children's future financial planning opportunities, by investing in a children's pension.

First, if their children are higher rate tax payers in future, they will benefit from higher rate tax relief.

Children's pensions have the lowest rate of tax relief that can be received, he said.

Secondly, the lifetime allowance has been reducing for the past few years – until this year, when it had a increase of £30,000 to £1.03m, and many jobs are seeing their standard pensions exceed the lifetime allowance, as for example NHS doctors, he added.

The lifetime allowance represents the maximum amount of money a saver can save in their pension pot with the benefit of tax relief at their marginal rate before incurring an additional tax charge of up to 55 per cent.

Martin Bamford, chartered financial planner at Informed Choice, agreed that a major downside of making pension contributions for children is the uncertainty over future withdrawal rules.

However, it is uncertain what the withdrawal rules will be this time next year, let alone in 50 to 60 years' time, so there is no greater risk in this respect, he said.