How can you give children a financial head start?

Call it clickbait or investment advice, but the recent headline in one national newspaper certainly captured attention. “How to make your child a pension millionaire by age 43”, it read, before extolling the virtues of a combination of pension plans for children and strongly-performing investment companies as the ideal way to give the kids a head-start on retirement planning – or get them over the line in fact.

But should financial advisers dispensing serious investment guidance really be recommending pensions as the ideal way to save on behalf of children?

We know the arguments – above all, there is free money on offer from the taxman here. Everyone, including children of any age, may put up to £3,600 into a pension plan each year and receive basic-rate tax relief of 20 per cent. This means the maximum investment for parents contributing on behalf of their kids costs only £2,880, with the pension provider then applying to HMRC for tax relief to top up the contribution.

That looks attractive for parents worried about their children’s futures. After all, it may be many years before they are able to make their own pension contributions. Even once they’re earning a salary, challenges such as student debt repayments, the need to save for a deposit on a first home and low wages at the beginning of their careers may get in the way of retirement planning.

Still, the case for pensions for children is not straightforward. For one thing, kids are

bound to have other priorities early in their working life for which financial help from parents might be much more welcome. Pensions are inflexible: children can’t use money invested in pensions on their behalf as a deposit on a home or to pay for a wedding – not unless they’re prepared for a long wait.

Another reason to be circumspect is that governments are prone to changing the rules. Children are already going to have to wait longer than their parents to start drawing down pensions – the minimum age is due to rise from 55 to 58 by the 2030s – but who is to say ministers won’t make all sorts of damaging alterations to the system over the next few decades.

Bear in mind too that the pension inheritance rules are now very generous, with no tax to pay on most pension cash bequeathed before age 75 and only income tax due on inheritances thereafter in most cases. That may be a better way to pass on pension savings to children.

The alternative recommendation for parents wanting to save on behalf of children is a junior ISA, where the allowance - £4,260 in 2018-19 – is already more generous than the pension threshold. There’s no tax relief upfront, but investments still grow free of tax and aren’t subject to tax when cashed in, unlike pensions.

As for investment companies, most advisers will have no argument with the newspaper’s suggestion that closed-ended funds represent a good choice of underlying investment for long-term saving. The industry’s superior performance track record over recent decades makes the case for this form of savings.

Investment companies are wise to the opportunity, of course. Most offer regular savings schemes that parents could use to invest on behalf of their children – significant numbers of savers already do exactly that.

Some investment companies already offer pension wrappers, though junior ISA arrangements are harder to find. But the alternative is to use a platform to supply the tax wrapper and access investment companies that way.

Find out more about the AIC's Saving for Children campaign here