Around the world, parents have common goals they want to achieve both personally and for their children. One of the most common is the ability to set aside money for the short- and long-term, but the majority of households find it difficult to save for their kids.
A recent survey highlights these issues among parents, noting that an average of £561 per child is set aside each year, equating to just over £10,000 by the time the child reaches adulthood. Although that amount is not pocket change, it doesn’t feel like enough for many parents wanting a stress-free financial life for their children.
If you desire to set your children up for financial success later in life, the good news is that you have a handful of options at your disposal. Saving even a small amount month to month can make a difference, particularly when tax-free accounts are used in the process. If saving is top of mind, options for Junior ISAs and SIPPs are helpful to understand both in how they work and the benefits parents and children receive from each.
Breaking Down Junior ISAs
A Junior Individual Savings Account commonly referred to as a Junior ISA, is a smart way for parents to save for their young children. For the current tax year, up to £4,260 can be set aside, and the funds in a Junior ISA are tax-free. Parents have the option of selecting a fixed-rate ISA for their children, or a shares ISA which allows for investment for the long-term. Both categories of ISAs have benefits, but special considerations as well.
The main purpose of a Junior ISA is to provide an incentive for parents to plan ahead financially for their children. A finance specialist from a website used to compare ISA rates explains that the advantages of saving in a Junior ISA extend well beyond setting up a savings fund. When parents use an ISA as an opportunity to educate their children about the benefits of saving for the long-term, showing them how a small amount of money grows over time, they are likely to make smart financial decisions when the funds reach their hands as an adult. This means children who receive Junior ISA savings when they turn 18 have a greater chance of utilising their money for further education costs, purchasing a home, or saving for their own retirement goals.
Benefits and Things to Consider
In addition to offering up a learning opportunity for children, Junior ISAs are full of other benefits. First, funds in the account are not taxed, either at the parent’s tax rate of the child’s, and they remain tax-free once the savings are transferred at the age of 18. There is also flexibility in how the funds can be used. Also, Junior ISAs can grow above and beyond the initial contribution from the parents. With a fixed-rate ISA, the amount of growth is capped at the rate provided by the financial institution, but there is little risk involved as the account balance cannot go backward.
With a shares ISA, parents have several investment options to choose from, some which may provide a higher rate of return than a fixed-rate option. However, there is risk involved in this choice, as investments are not guaranteed. Consider the options for how to save within a Junior ISA, and compare choices from various bank and investment providers to determine the best rate or investment plan available.
SIPPs for the Long-term
In addition to a Junior ISA, some parents opt to establish a self-invested pension plan, or SIPP, for their children. With this strategy, up to £2,880 per year in contributions can be made for a child. However, unlike a Junior ISA, SIPPs have an additional 20% tax relief added to the pot, creating a total of £3,600 in savings each year. Parents do not pay taxes on the money set aside in a SIPP, nor do children when they receive ownership of the account.
Where a Junior ISA automatically transfers to the child when he or she turns 18 and funds can immediately be used, a SIPP differs. This type of account has a much longer timeframe, as it is designed to be a vehicle for additional retirement savings. SIPP funds cannot be used without a penalty until the account owner turns 55, so it is important to consider the need and desire for long-term savings under this plan.
Advantages and Drawbacks
The biggest advantages to SIPPs for children is the ability to set them up for a financially sound future. Starting a child early down the path of saving for their own retirement can be an invaluable gift, as well as a teaching moment each year the account grows in value. Additionally, the tax relief that tops SIPP contributions is hard to come by in other accounts.
Parents should take note that Junior SIPPs often involve investing within the account, and that comes with the risk of loss. Also, SIPP contributions cannot be used for financial goals before the age of 55, so they aren’t well-suited for education funding or major purchases as a young adult. A Junior ISA is a better fit if these objectives are the priority.
Both Junior ISAs and SIPPs offer a powerful way to save, with their tax benefits, savings and investment options, and long-term timeframes. Parents should consider how and what they want to contribute to their child’s financial future before creating an account and take into account their own financial needs before doing so.