When investing for children, pensions are becoming a popular option. If you’re a parent, grandparent or family member, there is still a great tax-effective way to invest for your new offspring: get them a pension. Seriously, a stakeholder pension for babies is a great way to invest their future – read on to find out why.

• What is a stakeholder pension?
• Why set up a stakeholder pension for your child?
• Which stakeholder pension should you get?
• What’s it worth?

What is a stakeholder pension?

Stakeholder pensions were originally set up to give those on little or no income (women taking a break from work to have children, people on low pay or the jobless) the chance to add to a pension. This makes things a little fairer and lightens the load on the Government.

Although these pensions were originally set up with women and the unemployed in mind, anyone is allowed to set one up. This means that the child’s legal guardian(s) can set up a pension for newborns and take advantage of the decades until the child’s retirement in order to let the pension build itself up.

Once the stakeholder pension is set up, anyone can add to it. By investing a small amount for the child at the beginning of its life you can provide, through the wonders of compound interest, large sums of money for them in the future.

Check out our article on stakeholder pensions for more information. Also, see our step by step guide to getting a stakeholder pension.

Why set up a stakeholder pension for your child?

• The scheme is tax-efficient for you and your baby. You can pay in up to £2,880 each year. This is then topped up by the  government to £3,600 as a tax-back incentive.
• The fees are very cheap. The only way companies are allowed to charge you is through an annual fee of 1.5% on the total value of the fund that year, which drops to 1% after 10 years. Different providers charge different rates up to this maximum.  Find the best option in the section below.
• The money invested won’t be accessible until the child reaches 55. This means that they won’t be able to go on a spending spree with it at the age of 18.
• You can stop and start contributions as you wish, so if your cash situation changes you won’t be penalised for it. The minimum amount you can contribute at any one time is £20 gross (including the tax benefit). You can pay in nothing at all or up to £2,880 gross each tax year, in as many or as few installments as you wish. It’s very flexible.
• If granny and grandpa have some money to invest then they can use the stakeholder pension to leave money to their grandchildren without it being liable for inheritance tax. Anyone can put money into the pension fund when they wish so it’s something the whole family can get involved in.

Even if you can’t afford to invest the full amount each year, putting child benefit in for a rather longer period can create a sizeable sum too.

Once the child starts working, they can contribute to the fund with up to 100% of their income. They will receive the tax benefits if their income is less than £130,000. If the contribution to their pension is greater than £255,000, they will incur a 40% tax on the excess.

How much is a stakeholder pension worth?

To look at the benefits of a stakeholder pension in real terms, we’ve worked out an example.

If you invest a total of £2,880 each year for the first 10 years of the child’s life then by the time they reach 55, which is the minimum age at which they can access the fund, they will have well over £700,000 to spend. If they wait until they’re 70, they will have more than doubled that and have a total of over £1.8 million.

Not a mean amount considering this does not include any additions to the fund throughout the child’s working life. Given the typical person, or their employer, will add to a pension fund over the course their life then the amount they will have on retirement is likely to be more than this figure.

This example is based on an average annual return of 6%. The stakeholder pensions are normally used to invest in indexed-tracked funds, which means that there is some risk involved. These funds are managed by computers rather than by people in The City. This is a good thing, however, as index-tracked funds tend to perform better over long periods of time.

They are limited on how they can use the fund however. They can take up to 25% as a tax-free lump sum payment but must use the rest to purchase an annuity that will pay them an income for the remainder of their life. For more information read our article on annuities and how to get the best one.

Which stakeholder pension should you get?

There is a minimum set of standards outlined by the Government so you are pretty safe when choosing which companies to invest with. If you want to compare different options then Moneymadeclear has a decision tree that will guide you to the best stakeholder pension option for your situation. You are able to transfer the pension fund to a different stakeholder pension provider at no cost so it is possible to switch if you’re situation changes.