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2022-12-21 17:05:54 By : Mr. langbo Lee

Stuck for a last-minute holiday gift for your children?

Picture this scene on Christmas morning: Children gather excitedly around the tree, their faces light up when they see an exquisitely wrapped envelope bearing their names. Their eyes open wide in wonder, followed by … puzzlement. “What’s a SIPP?”

Merry Christmas! The short answer is: A SIPP is a Self Invested Personal Pension plan. It is an extremely tax-efficient means of saving for retirement. Contributions attract tax relief, gains build up within the SIPP free of tax, and any residual funds left after your death is usually free of inheritance tax too.

What many don’t realize, however, is that contributions up to £2,880 ($3,570) per annum can also attract tax relief at the basic rate of 20%, even when the beneficiary has no income. The addition of 20% tax relief takes the value of a £2,880 contribution right up to £3,600.

Junior SIPPs, which are available to any child up to the age of 18, are designed to take full advantage of this. You must be the child’s parent or legal guardian to open one, and you will need to provide your National Insurance number and one for your child too if they have one. Nevertheless, the process is pretty painless and it can take as little as 15 minutes to open an account online, making it an ideal last minute gift. 

Yet a pension contribution at such a tender age is likely to prove the most valuable gift they will ever receive. Even compounding at a relatively modest 5% real annual growth rate over 50 years will transform the initial £3,600 investment to almost £44,000 in today’s money. In nominal terms, that could reach almost £200,000 if inflation were to average just 3% over the intervening period, even if you were to make no further contributions. And remember that the initial £3,600 only actually cost you £2,880 in the first place.

There is a wide range of investment choices too, although for this sort of ultra-long term instrument, it would be appropriate for most, if not all, of it to be exposed to the stock market. A low-cost global equity fund would probably be the best choice to begin with. As a general investing rule of thumb, longer investment horizons leave more time for short-term volatility to be smoothed out and allow compounding to work its magic.

In these straitened times, clearly £2,880 is a hefty sum to be gifting into an offspring’s pension, no matter how cherished they are. However, it is possible to start with regular monthly contributions of around £25 a month or by simply making a smaller lump sum payment. Typically, the minimum contribution is around £100, which would still gross up to £125 thanks to the tax relief. 

The same principle can apply to adults too with ordinary SIPPs. Any non-working partner would be eligible for the same £720 tax uplift from £2,880 to £3,600, even if they earned nothing in any given tax year. This can be ideal for staying on track for retirement when someone takes a career break.

There are, of course, other means of helping children get into the investment habit and understand the intricacies of compound interest and tax relief. Junior Individual Savings Accounts (JISAs), for example, are a good choice for those unwilling to force their children to wait 50 years to benefit. Again, a parent or guardian must open the account, but the child is free to withdraw the money once they reach 18.

There is no tax relief, but money builds up tax-free within the JISA, and unlike a SIPP it can also be withdrawn free of tax. The annual JISA limit is higher at £9,000. For completeness, if your parents are very rich, children aged 16 or 17 are entitled to the adult £20,000 a year ISA allowance, in addition to their JISA allowance.

One trap to beware of, though, especially with interest rates rising, is that money gifted from a parent into a child’s savings account with a bank or building society might attract tax. If the annual interest is greater than £100, the income is taxed as though it accrued to the parent, not the child. For that reason, grandparents often make such contributions.   

Sure, your five-year-old may not thank you for such a generous gift. But eventually they’ll appreciate the financial start. After all, a pension is for life, not just for Christmas.

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This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Stuart Trow is co-host of “Money, Money, Money” on Switch Radio and author of “The Bluffer’s Guide to Economics.” Previously, he was a strategist at the European Bank for Reconstruction and Development.

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