Many of your clients may have been pondering over what to get their children for Christmas.
It could be the toy to take them to infinity and beyond, of they may have to get creative when they find that they can’t get hold of this year’s ‘must have’ present for love nor money?
Well, here is another present idea which, although may seem boring, their kids may eventually thank them for.
Give them a pension, or top up one if they have one already.
Even for a techie pension-type like me this seems as boring as a set of underwear and socks, or the sensible shoes you never wanted for a present.
But in the long run this could save your clients’ kids from having to work for much longer than our generation will.
Now comes the part a techie-type never finds boring.
It is all in the numbers.
The assumptions
To make this easy, let us assume that the client has a child born this year.
They will start working at 18, and in real terms they will have £500 a year paid into a pension through auto-enrolment for the rest of their working life.
I know what you are thinking. This seems modest, but for the sake of the numbers you will see why I’m using this soon.
We will also assume growth in the pension fund of 7 per cent, as it is fair to say you can probably go a little riskier given the investment time frame, inflation of 2.5 per cent and charges of 1 per cent year. Basically, a net of 3.5 per cent growth factoring in charges and inflation.
The benefits will be taken at 65.
We do not know what will happen to the state pension in the future, but we do know that 65 will be before the child’s state pension age, so this may help bridge the gap.
Instead of them spending a lot of money on their child, let’s say they pay £400 to their pension, as it’s a third-party contribution it will qualify for tax relief, making the gross payment £500.
We are assuming a ‘relief at Source’ pension scheme will be used.
The results
Based on all of the above, if your client paid £500 a year for 18 years into a pension for their child, at age 65 that pension pot will be worth £63,865.66 in today’s terms.
That is not a bad return for a net outlay of £7,200 (18 years of the £400 net contribution that is grossed up to £500).
Let us compare this to the child having £500 paid into their pension from 18 to 65, which adds up to 48 years total contributions.
That gives the child a real term pot of £62,300, which is clearly less than if they had paid in from 0 to 18 years of age.
And to have that smaller amount it will have cost the child £19,200 net (or £12,000 more than you paid).
That is the massive effect that compounding can have given the extra investment term.
At age 18 the pot your client has contributed to is only worth £12,678, but leaving that to grow until their child is age 65 means it grows to just over five times that amount.
The reality
Most people will want their children to have a smile on their face on Christmas morning which will be hard to achieve by showing them a statement saying where their pension money has been invested.
But, even if it is not a winning Christmas present idea for your clients, the same result could be achieved by them spending £33.33 net per month on pension contribution, the equivalent of £1.10 a day.
If your clients are in the fortunate position to be able to fully fund their children’s pension, placing £3,600 gross into a pension per year until they are 18, that would give them a massive £459,832 in real terms at age 65.
So while we get a bit contemplative at this time of year, and look forward to catching up and having a meal with family, this is some real food for thought and could help to wrap up Christmas for many years to come.
Mark Devlin is a senior technical manager at Prudential UK
