Of course, your little ones are unlikely to care for a good few years yet but when you introduce the notion of saving this should give them something to think about, when the time comes! Here at Babyworld we show you how to give your child a gift that he won’t grow out of for 65 years.

A newborn has nothing but time – and that’s something this
strategy exploits to the fullest.

We’d all like to be millionaires. Money worries are something
virtually all parents have to face at one time or another.

As a parent, you are in the lucky position of being able
to give your children a boost towards that millionaire status by starting
a pension or savings plan, and taking advantage of the miracle of compound
interest and a moderately generous government.

According to a study by credit card provider Virgin Money,
new parents receive gifts worth £660 on the birth of a new baby. This
is very nice, but your baby will have grown out of all the new clothes
within a month and you hardly need two new all-terrain buggies. By starting
a pension with this £660 lump sum and adding your child benefit every
month; by the time your baby is thinking about retirement, they could
already have a million pound pension fund.

First step – start a pension

Pensions immediately conjure up images of elasticated knitwear and poverty.
However, their bad reputation isn’t completely justified. They just make
the most of the miracle of compound interest and a moderately generous
government.

Put simply, a pension is a long term savings plan which receives a tax
boost from the government. The money you pay in is invested to produce
long-term growth. There are many providers and investment strategies available,
all offering different levels of risk.

Normally, you start your own personal pension, and use your earnings
to pay into it during your career. Setting up a pension for a baby means
that the parents pay into it initially, but the child can choose to continue
it later on.

The pension provider charges annual fees to manage your fund. The level
of charges for stakeholder pensions is capped by the Government at 1.5%
of the fund value per year for the first ten years, and 1% afterwards.
The stakeholder model is a low-cost personal pension plan.

The tax breaks

The major advantage of a pension is the tax-breaks. To encourage people
to save for retirement, the Government will ‘top-up’ any contributions
you make by either 22% or 40%, depending on how much income tax you pay.

If you are a standard rate taxpayer and put £100 into a pension, the
Government will add £22.

For higher rate taxpayers, £40 will be added for every £100 invested.

This effectively means that when you pay in £100 to your fund, £122 or
£140 is actually added to the balance. Only the first £2808 invested every
year will be topped up in this way.

The Government gets this tax back when you retire. The monthly income
you receive is taxable, just as if you were paid a salary.

The advantage is that during the time you hold the pension, the additional
money contributed by the Government helps to increase the fund value.

Route to a million

Starting a pension is a fantastic financial boost, although it doesn’t mean
that your baby won’t need to save for their retirement independently. They
can continue to pay in to the fund you have established, or join an employers
pension, or start their own scheme later in life.
Here are the steps to take:

• Find yourself an experienced independent financial advisor who specialises
  in pensions. They will help you decide a level of investment risk you
  are happy with and recommend an appropriate plan.
• Invest a £660 lump sum into a low-cost stakeholder pension on the
  birth of your baby. The Government will add another £145 in tax relief,
  making the total contribution £805.
• Add your monthly child benefit of £72. Tax relief will boost this
  by 22% to £88 per month.
• Keep making these monthly contributions until your child reaches
  18.
• Assuming a 9% long term growth rate, the fund is now worth £50,922.
• Stop paying into the pension.
• If long term growth stays at 9%, compound interest means that the
  fund will be worth £1.9 million at age 60. Even if you stop contributing
  at age five, the fund will be worth £903,000 at retirement.

Before you decide…

Although the idea of making your child a millionaire is tempting, there
are potential drawbacks which you need to factor in:

• The fund can’t be accessed until age 55. Make sure you won’t need
  the money for university or school fees.
• The value of investments can go down as well as up. In the long term,
  the ups and downs tend to even out, but this is not guaranteed. Investing
  in shares is inherently risky. The average long term growth of the stock
  market is 11%, but I have used 9% in the example.
• Inflation will erode the value. A million pounds is a lot of money
  now, but in 55 years it might only buy a couple of fun-sized Mars Bars.

Alternatives

In order to make your baby a millionaire, any money invested has to be
left alone to grow over a long period of time. If you are unsure about
tying the money up for 50-60 years, you can adopt a mix-and-match approach
with some money in a pension as well as using your child Child Trust fund
allowance (CTF).

Child Trust Funds

Babies born after 2002 receive a £250 Child Trust Fund (CTF) Voucher.
When the child reaches the age of seven, the Government pays in another
£250.

You can choose between savings, shares and stakeholder accounts. The
latter two invest in equities, and carry all the associated risks.

You can put up to £1200 per year into a CTF account. The account is in
the name of the child, so when they reach 18 they can withdraw the money
tax free. If they want to blow it all on inappropriate members of the
opposite sex and partying, sadly there’s nothing you can do about it.

A CTF account is rather like an junior ISA. It has the same tax advantages,
but a lower annual contribution limit and a smaller range of providers.
If you find that you have money to spare, consider using some of your
ISA allowance to build up a tax-free lump sum.

This has the advantage of being in your name, so you have more control
over what it is used for! Whatever method you choose, make sure you shop
around for the most competitive account, and change providers if you aren’t
happy.

The pensions system is undergoing huge changes. Future pensioners will
have to take more personal responsibility than ever before for their retirement.
By saving for your baby, you can give them a gift that they won’t grow
out of for 65 years.

by Olwen Jones