Building a nest egg for your child can provide them with a great start in life, as well as financial security as they grow older.
Opening a Junior ISA when a child is born could provide the means to support them through higher education or onto the property ladder. Starting a pension early is a great way to instil the importance of saving for the future, as well as providing a good foundation for contributions in adulthood.
Recent reports, however, suggest that 4 out of 5 parents currently saving for their children are doing so exclusively in cash.
Here are three reasons why this might not be the best idea.
1. The impact of inflation
The main reason why saving for a child in cash could be a bad idea is the effect of inflation.
Poor rates have meant a nightmare for savers stretching back at least to the 2008 financial crisis. Currently, with rates still low and inflation on the rise, the buying power of funds held in cash is being greatly diminished.
Inflation rose above the Bank of England’s target of 2% in May 2021. It rose again for the year to June, increasing to 2.5%. This marks the highest it has been for nearly three years.
While being frugal and putting money aside for your child’s future is great, holding large amounts in cash could see that fund effectively losing value in real terms. This could signal a need to take a greater level of risk.
2. Investment products can be tax-efficient
An Individual Savings Account (ISA) is a tax-efficient way to save. A Junior version (a JISA) is available to any UK resident under the age of 16.
You can open a JISA on your child’s behalf and contribute up to £9,000 during the 2021/22 tax year.
As with an adult ISA, there are two main types:
Both are tax-efficient options; however, the added risk of a Stocks and Shares JISA comes with the potential for greater returns.
There is no tax on interest in a Cash JISA and any profits on a Stocks and Shares JISA are also tax-free.
Control of the JISA is given over to your child from age 18.
A Junior SIPP
Pensions are also a tax-efficient way to build a nest egg for your child. Before your child begins to earn a wage, you can pay up to a limit of £2,880 a year into a pension on their behalf.
Tax relief on contributions means that this amount will be topped up by the government, resulting in a total investment of £3,600 a year.
The drawback to a pension is that your child won’t be able to access the funds until they reach at least age 57. This means it won’t be a suitable way to provide funds for a first home, for example.
As well as tax relief on contributions, your child will be eligible (under current rules) for up to 25% tax-free cash at retirement.
3. The potential loss of investment returns
Money held in cash is secure – up to the £85,000 limit protected by the Financial Services Compensation Scheme (FSCS) – but with rates low, you won’t gain much interest and your funds will be vulnerable to the effects of inflation.
Investing in products such as ISAs and pensions, however, could see your fund keep pace with, or even beat inflation. The value of funds held in the stock market can rise as well as fall but the general trend over the long term is upwards.
Understanding your risk profile means taking a level of risk that you are comfortable with. But remember that the biggest risk could be not taking any risk at all.
We can help you evaluate your attitude to risk and build a portfolio that works for you.
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Saving for your child can help to teach them the value of money while also building a foundation for their future financial security.
The general trend of the markets is upwards and that means that starting early gives the money you put aside the best chance for growth.
If you would like to discuss investing in your child’s future, please contact us today.
The value of your investments (and any income from them) can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance. Investments should be considered over the longer term and should fit in with your overall attitude to risk and financial circumstances.
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