Perhaps you’re thinking of starting a family, or already have some little nippers. The list of things they need is undoubtedly endless. School uniform (why won’t you stop growing!), shoes, bikes, toys, games, stocks & shares ISA, pensions…wait, sorry, did you say ISAs and pensions?! Yup.
What’s the issue here? Just look to the poor millennials.
As extravagant as investing for your children might sound, you only need to look to the young adults of today to see the financial hardship they could face down the line.
Millennials are a case in point, and you don’t need to go far for tales of woe. Aged between 26 – 40, this generation are struggling hard with their finances.
They were the first to pay for higher education after the introduction of tuition fees in 1998. As a result, they have debt averaging £50k following their degrees. And that’s before they’ve even started on the typical expenses that straddle young adults: cars, marriages, children, houses, and the like.
The housing market in particular has been brutal for them. It’s transferred wealth to older generations and made ownership increasingly difficult. In 2004, 44% of people under 35 owned their own property. That figure is now 34%, and declining.
They’ve also entered the workforce and suffered two crises in a decade. 43% have zero emergency savings. 44% don’t own a pension. Do you think these hardships will let-up for future generations?
The first hurdle in investing for children: inflation
So, you want to help. First thought might be: I’ll just stick some cash in a savings account for when they’re 18. This is fine. But with inflation higher than interest rates, and interest rates very unlikely to climb any time soon, all likelihood is that pot will be worth less than when you started.
Independent financial adviser (IFA) Felix Milton agrees:
“The main issue [with savings] is inflation. It’s important to note that £100 today is worth more than £100 in 10 years’ time. This is because inflation erodes the true value of money.”
Tax is your other problem. If you gift more than £3k in a year, and die within 7 years of that gift, it’s taxable.
How to invest tax free for their future
Investing for your children at least offers the chance of some inflation beating returns. Felix adds: “Remember that a child has time on their side, and time and compounding are perhaps the two most powerful forces you can have for investment returns”.
Again, taxes need considering. This is because investing in any old account could attract taxes on the growth of your money (capital gains), or income (dividends) from it. But you need not worry. There are two tax sheltered options which more than adequately deal with your needs. These are the junior ISA and the junior SIPP.
Both are set-up by parents or guardians and sit outside of their tax provisions. What’s attractive is anyone can put money into them, and the parent or guardian makes investment decisions on the child’s behalf.
The junior ISA is much the same as an adult one, except you’re limited to £9k contributions. This is then split however you like between a cash or stocks & shares ISA. When the child comes of age at 18, the junior ISA will automatically switch to a full adult ISA for them to use ‘til their young heart’s content.
A junior SIPP differs in that your contributions will be topped up by 20% tax relief from the government, to a max of £3,600 gross per year. This means you can put in up to £2,880 a year, and the government would top you up to a maximum of £720.
Like an adult SIPP however, the child can’t touch it until they’re 57 (it will probably be later by the time they reach that age!), at which point 25% can be taken tax-free and the remainder taxed as income. Think of it as the government lending your tax to you to make extra returns, before asking for it back once you retire.
Deciding which is best: junior ISA vs junior SIPP
The key here is essentially access for the child once they come of age. Felix summarises the decision between the two:
“Some people take issue with the fact: how responsible are you at 18? You will have to weigh up how much you want them to have access at that age. For me personally, I think the Junior ISA can alleviate a lot of financial pressure at a key stage in their lives. You may not be the most responsible. But you might be going to university, and then after that, settling into adult life and the expenses that come then.”
Finding the right investments when investing for children
Stocks & shares ISAs and SIPPs can invest in the full range of assets and funds out there. Shares, bonds, property, alternatives – you pretty much name it. Felix gives his thoughts on investments for these portfolios:
“With ISAs, you really have to consider how much time you have between the age of your child now, and 18 when it becomes legally theirs. The traditional adage is: you need a minimum of 5 years to consider a stock market investment, and ideally 10 – 15 years for a long-term view. This can have a sway on how much [of the child’s portfolio] is in defensive assets versus riskier equities.”
“With pensions for a child, don’t let your assumptions and thoughts on risk really come into it. The child is young, and should be 100% in the stock market – in equities. When you look at global equity returns over the past 50 years, they are far superior than a low risk steady approach. As long as what you’re investing in is sensible.”
Steps top three tips for selecting investments
- Remember the timeframes when investing for children. For a junior SIPP, this could be anywhere up to 60 years. Longer timeframes enable you to invest in riskier assets for a potentially higher reward. Classically, more defensive assets include cash and bonds, and riskier assets include shares and alternatives.
- Find competitively priced investments. The longer you’re invested, the larger the dent higher fees will inflict on your returns.
- No matter how long you invest for, individual stock investments are still extremely risky, as you are exposed to the fate of a single company. In our opinion, funds are a much more sensible way to invest, as your money is spread out over numerous companies.
Fund ideas, Adrian Lowcock – market commentator
Junior ISA – Fundsmith Equity
“Terry Smith has a long term focus and invests in large companies around the world which he believes offer the potential for long term growth. He looks for companies with strong cashflow generation, enduring brands and defendable patents.”
Junior SIPP – ASI Global Smaller Companies
“A global smaller companies fund which offers the potential for long term growth and the global focus means the fund can respond to changing opportunities overtime. The focus on change ethos which runs through the fund means it is well suited for investing over the long term.”