PensionsMay 9 2018

Danger of children's pensions laid bare

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Danger of children's pensions laid bare

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.

He said: "For parents with sufficient disposable income, funding a pension for children can make good financial sense.

"Any investment made over such a long-term benefits from a serious amount of compounding, especially with tax relief added to the contribution at outset."

Mr Bamford's clients often have reservations about funding a Junior Isa, which is a popular choice of savings for children, giving them access to their money at age 18, when it becomes a standard Isa.

This product is viewed as a "motorbike fund" he said, with a high probability the proceeds will be spent irresponsibly when the child celebrates his or her 18th birthday.

He said: "Investing in a pension instead locks the money away to create long-term wealth, taking some pressure off the child during the first decade or two of their career so income can go towards other financial priorities."

For Gem Durham, independent financial adviser at Obsidian, the primary concern of her clients is "whether their children/grandchildren will be able to buy a house and fund their living expenses through university," so she opts for junior Isas.

She said: "My clients who could afford to also contribute towards grandchildren's pensions don't do it, because they are not yet old enough to feel able to give away that much wealth in case they need it."

Alan Chan, director and chartered financial planner at London-based IFS Wealth & Pensions, argued that children's pensions "can be a good idea but they are rarely taken up in practice". 

He said: "This is usually because there are more pressing priorities to address, such as university fees, money for a house or deposit in future. 

"So the money ends up being put into an alternative product such as a junior Isa instead."

maria.espadinha@ft.com