With the cost of education and housing rising, it’s become more commonplace for parents and grandparents to save for their children and grandchildren. By planning ahead, they can maximise the impact those savings will have.
What’s your outcome?
Whether you’re saving for yourself or your children, the first thing to think about is why you’re doing it. This focuses your mind on your goal, and gives you a timeline for your investment.
The first big-ticket items that most parents say they want to help their children financially with are either a car or going to university. Other popular reasons to save for your kids include travel, a wedding or to help them onto the housing ladder.
Where to save?
You’ll need an account or wrapper for the money you’re saving. You could use:
- A straightforward bank account, in your name or your child’s
- An ISA in your name (your child is eligible at age 16)
- A Junior ISA in your child’s name
- A general investment account to put money into the stock market, in either of your names
- A pension in your child’s name (they’re eligible from birth!)
Each wrapper has advantages and disadvantages, and when you’d like your child to access the money is an important factor.
If they’ll need it within the next five years, you should stay out of the stock market and use a savings account.
If they don’t need to access it for at least five years, and preferably seven or more, then the returns offered by the stock market should be taken via an ISA or investment account. Over the long-term, you should be looking at around 5%+ annual returns at the lower end of expectations.
A Junior ISA is a popular option because it’s easy to open one. But it comes with a potential downside: at age 18, the money automatically reverts into your child’s name and becomes their property – so your plan to save for university fees may turn into a car or holiday instead!
If you’re taking a long-term view towards their retirement, which can be a great option for grandparents looking to leave a legacy, then you should use a pension fund. You can save up to £240 a month in a children’s pension – but they can’t access the money until they reach retirement age. That’s currently 55 years old but is certain to rise by the time a child born today gets there.
The big advantage of using a pension is the vast amount of time the savings have to enjoy compound interest. That means a modest amount can become substantial: saving £50 every month from birth until age 25 will turn into £1m by retirement age if the pension averages 9% annual returns.
Although that’s a best-case scenario, it highlights the benefit of the pension option and the power of compound growth over time.
How much risk should you take?
As an investor, the returns you get are linked to the amount of risk you’re prepared to tolerate. You can decide how much exposure to the stock market you want in your investment, and the longer the investment, the more exposure you can risk.
For a pension in your baby’s name, the money will be in the markets for over 50 years, so you can go for up to 100% exposure to the market in the early years. Peaks and troughs are inevitable, but with so much time on your side you should try to maximise potential returns.
As your child gets older, this level of exposure should be adjusted. By the time we reach retirement, we don’t typically want a lot of our investment in the markets because we need more certainty on our money.
Whichever vehicle you use, as a parent or grandparent start with the outcome you want and use that to determine how you can best help your loved ones.