How a contribution to your child’s pension could boost their financial security

As a parent, you might worry about your child’s long-term financial wellbeing. While you might consider supporting them through university, helping out with day-to-day costs, or handing over a home deposit, have you thought about contributing to their pension? It could go further than you think.

Younger generations face some key challenges when saving for their retirement. As people are living for longer, it’s likely workers today will need a retirement plan that will provide an income for several decades.

In addition, financial pressures on household budgets may mean employees are more likely to reduce or pause pension contributions.

Indeed, a Royal London survey found the cost of living crisis has led to a third of workers investigating whether to cut pension contributions. Among employees aged between 18 and 34, the figure rises to a worrying 49%.

While altering pension contributions may boost household budgets in the short term, it can have a significant effect on financial security later in life. As pensions are invested over the long term and benefit from compounding, even a temporary pause could affect their standard of living in retirement.

So, if you’re thinking about how you could lend financial support to your child, reviewing their pension could be valuable.

The power of compounding can transform regular pension contributions into a sizeable pot

Thanks to tax relief and long-term investment growth, the money you deposit in your child’s pension has an opportunity to grow to several times the value of the original deposits.

According to PensionBee dated September 2023, a parent placing £200 a month in their 18-year-old child’s pension for 20 years would contribute £48,000 in total.

Once tax relief, investment returns of 5% a year, and an annual management fee of 0.5% are factored in, it’s calculated the value of the pension would rise to almost £330,000 by the time the child is 64.

Even smaller deposits can add up. Under the same circumstances as the above scenario, depositing £50 a month in your child’s pension over 20 years could lead to a pot of more than £80,000 even though you’d have deposited just £12,000.

You don’t even have to wait until your child reaches adulthood to start paying into a pension on their behalf. Those not earning an income, including children, can deposit up to £2,880 into a pension in 2023/24 and still benefit from tax relief. By investing sooner, the effect of compounding could be even greater.

Of course, investment returns cannot be guaranteed, and all investments carry some risk. However, the above examples demonstrate why you might want to consider pensions if you’re weighing up ways to support your children financially.

A key downside of contributing to a pension is that they’re usually not accessible until the pension holder reaches pension age. This is currently 55, rising to 57 in 2028 and it could change in the future.

3 reasons you may want to consider using your child’s pension to pass on wealth

1. Pension contributions could support long-term financial security

If you’re concerned about your child’s long-term financial security, a pension could be useful. As a pension cannot usually be accessed until retirement age, you can rest assured the deposits won’t be spent on short-term outgoings.

However, it could also mean your gift couldn’t support your child in reaching other milestones or if they faced financial difficulties. As a result, you may want to consider how to balance the support you offer as part of your overall financial plan.

2. Pension contributions benefit from tax relief

One of the key reasons why pensions are efficient when saving for retirement is that contributions usually benefit from tax relief. So, the money you gift to your child through a pension may receive an instant boost that could mean they have more flexibility in retirement. Tax relief will be paid at your child’s marginal rate of Income Tax, rather than yours.

3. Pension contributions could be invested for decades

The earlier example demonstrates the power of compounding – making contributions to your child’s pension early in their career could lead to a pot with a value far beyond your initial deposits. While investment returns cannot be guaranteed, the money you place in a pension could be invested for decades, which provides an opportunity for significant growth.

Keeping the pension Annual Allowance in mind could help your child avoid an unexpected tax bill

If you’re thinking about boosting your child’s pension, it may be a good idea to talk about their income and other contributions to avoid a potential tax charge.

The Annual Allowance limits how much you can place into a pension each tax year while retaining tax relief. In 2023/24, the Annual Allowance is £60,000 for most people. However, tax relief is restricted to net relevant earnings, so it’s potentially important to understand your child’s income.

The Annual Allowance may also be lower if the pension holder is a high-earner or has already taken an income from their pension.

Exceeding the Annual Allowance could lead to an unexpected tax charge to reclaim the tax relief paid. So, talking to your child about the money that goes into their pension might be important.

Contact us to discuss how to improve your children’s financial security

Contributing to a pension is just one way you could improve your child’s financial security. You might want to set aside assets for them to inherit or gift a property deposit too. Making your family’s long-term finances part of your plan could give you confidence and help you achieve your goals.

Please contact us to arrange a meeting to discuss your options.

Please note:

This blog is for general information only and does not constitute advice. The information is aimed at retail clients only.

A pension is a long-term investment not normally accessible until 55 (57 from April 2028). The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Past performance is not a reliable indicator of future results.

The tax implications of pension withdrawals will be based on your individual circumstances. Thresholds, percentage rates and tax legislation may change in subsequent Finance Acts.

The Financial Conduct Authority does not regulate tax planning or estate planning.

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