Recent data from the Department for Work and Pensions reveals that 38% of working age people, around 12.5 million savers, are not saving enough for their retirement. With both increasing life expectancy and many workers struggling to save, this is creating a ‘perfect storm’ for future retirees from the younger generations.
A number of parents and grandparents I speak to are particularly concerned about their family’s financial futures and whether their pension savings will be sufficient to support them throughout retirement.
Supporting their future
Valuable defined benefit pensions – which many of the retiring generation benefitted from – are few and far between, and current day workers are not saving enough into defined contribution pension schemes. As such, what can you do from a financial planning perspective to help your descendants?
Pensions for children and grandchildren
Saving for retirement might not be something you think about starting in childhood, but creating a pension for your children or grandchildren– even though they’re decades away from retirement – can set them on the way for future financial wellbeing. Not only are pensions a tax-efficient way to save, setting up a pension as early as possible means even small contributions have more time to grow.
A child can have a pension from birth – there’s no minimum age. Only a parent or guardian can open up a pension for a child, but once it’s up and running, anyone can contribute – parents, grandparents, godparents, friends or other family members.
The maximum annual contribution is £2,880. When you take into account an additional 20% in tax relief from the government, this totals a gross contribution of £3,600. In addition, any investment returns generated by the pension won’t be subject to Income Tax or Capital Gains Tax.
Let’s look at an example
You decide to make a pension contribution for five years once your child is born, the total cost would be £14,400 with tax relief obtained of £3,600.
Projecting this forward and targeting a reasonable level of investment return at 4.5% above inflation, forecasted to be 2% over the long term, the pension valuation in real terms at age 60 is forecasted to be £212,883.
Children who are now working
Although we have discussed making pension contributions for family members with no earnings, you can also provide support to those who are already working.
It is estimated that 21% of workers are opted out of their workplace pension and consequently, not benefitting from employer contributions or tax relief.
UK pension regulations on workplace pensions require that an employer must contribute at least 3% into a worker’s pension provided they are making contributions of 5% or more. Often employers are more generous than this, matching contributions up to a specified amount.
Let’s look at an example
An employee earns £30,000 per year. At present, they are making no pension contributions but their employer will match up to 5%. You are prepared to help make pension contributions on their behalf:
Employee’s existing contributions – £0
Cost to you for new contributions – £1,200
Tax relief – £300
Employer contributions – £1,500
This means that each year, the employee will accumulate a £3,000 contribution in the pension at a cost to you of £1,200.
If we forecast this forward from age 25 to age 60, again assuming a 4.5% real return, the total pension value is £224,494 at a cost of £30,000.
These examples of inter-generational financial planning will provide a significant boost to your family’s pension savings. Having a growing pension pot offers valuable peace of mind, meaning children and grandchildren can focus on achieving their financial goals when they reach adulthood and have a better chance for a comfortable retirement.
Alternative options
It is important to consider alternative tax efficient saving options to support your family. A pension is inaccessible until a person’s retirement. At present, the minimum retirement age is 55 and this is increasing to 57 in 2028. But you may wish to support your family financially with earlier events, such as a house purchase, a wedding, or education costs.
This is where using an Individual Savings Account (ISA) may help to meet your family’s goals.
A Junior ISA can be set up from the day a person is born with contributions of up to £9,000 per annum. They will have access to the money from age 18, after which a traditional ISA can be used with a contribution of up to £20,000 each year with access available at any time.
One further ISA to consider is the Lifetime ISA. Contributions can only be made once a person is age 18 or over. Within the Lifetime ISA, the government will add a 25% bonus on any contributions made up to £4,000 a year, meaning up to an extra £1,000 can be received as a bonus. The money must be used for a first house purchase, and some specific rules apply such as the maximum house value, or after age 60.
Within all ISAs, investment returns and withdrawals are free from Income Tax and Capital Gains Tax.
Further tax benefits
Within this article, we have covered a number of benefits for your family. However, there can be benefits to the person making the gift too.
Each person has a £3,000 gifting allowance each year which moves the gift outside of the estate for inheritance tax immediately. Above this, the gift will take 7-years to fall outside of the estate.
If regular income is higher than regular expenditure, then gifts made out of surplus income will fall outside of the estate immediately, provided that they are regular and habitual, such as making annual pension contributions on someone else’s behalf.
The importance of financial advice
If you are considering making pension contributions or other savings for family members, it’s important to seek financial advice, so you can find the right balance between supporting their needs whilst achieving your own financial goals.
Please speak to an Origen adviser who can help you put a plan in place taking advantages of these opportunities.
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