Contributions to a Child’s Pension

Neil Stewart is a Financial Adviser holding the Diploma in Regulated Financial Planning. This article is not financial advice, it is for your general information and is not intended to address your particular requirements.

Einstein allegedly once described compound interest as the “8th Wonder of the World”. Whether he actually ever said this or not is up for debate, but there’s no question that the compounding of interest, or investment returns is a fantastic thing.

The basics are simple, if you invest £100 and receive a 5% return in the first year, you now have £105. If you achieve the same return the next year, the 5% growth is applied to the £105, not just the original £100. The longer the timeframe, the more the impact of the compounding.

Which leads me to my point: Can you imagine the benefits of compounding returns over a 60-year period if you made a pension contribution for a baby?

Forgetting the very real downsides of such a strategy for a moment (I’ll come back to them), every individual under the age of 75 can contribute at least £2,880 to a pension, even newborns. HMRC then gross this figure up to £3,600.

A £3,600 gross contribution into a newborn’s pension, allowed to grow at a rate of 5% after all charges could be worth £72,293 after 60 years.

Getting a little more adventurous with the investment choice and a 7% return could be worth £239,974 after 60 years.

“But I wouldn’t be around to see them benefit!”
“But they will need the money before then!”

Are both very valid arguments against making pension contributions for children.

But, if you think of it another way:

“A gift of a step towards financial security in retirement, reducing any worries in adult life of being able to retire in comfort.”

Most people worry about retirement and whether they will have enough money to live on. Wouldn’t it be great to be able to give the gift of reducing this stress?

As is often the answer, a balanced approach is necessary. I would suggest that in most cases, a contribution to a Junior ISA or a Lifetime ISA (for over 18s) is a more suitable first investment due to the capital being accessible earlier.

However, after a more immediate need has been taken care of, a pension contribution for a child certainly has its place.

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Risk warnings:

The price of shares and investments and the income derived from them can go down as well as up, and investors may not get back the amount they invested.

The investment growth figures quoted in this article are merely examples to consider the power of compounding.

In reality, investment returns differ year on year and losses are also possible.