Christmas gifts with a difference

Parents, friends and family love to hand over a big gift-wrapped box to a child at  Christmas. But it’s worth considering a present with a more lasting effect, a Christmas investment for children. You could even make them a millionaire, which sounds like a pipe dream, but if you start saving early, it’s an achievable goal. There are tax benefits for them – and you too.  

The most obvious is to set up or pay into an existing Junior Isa. Unlike the latest fad with toys or computer games, investing into a junior Isa isn’t just for Christmas. It’s a gift with long-term benefits. The money is locked away until the child reaches the age of 18, and even a small amount could build up to a significant figure over time. In the current tax year you can put £4,080 into a junior Isa.

Like the adult version, there are two types of junior Isas: cash accounts and stocks and shares accounts, which can hold a variety of investments including equities, unit trusts, bonds, gilts, open-ended investment companies and exchange-traded funds.  Since this is a long-term investment, a stocks and shares account might be smart given that over 18 years they will outperform cash, especially as interest rates are currently low and inflation is rising.

Another alternative is a pension. It might seem an absurd concept to think about retirement for a new-born baby, toddler or teenager, but the argument is compelling. It’s all about being tax-efficient. Pensions benefit from tax relief on the contribution, tax-free growth and a tax-free lump sum at retirement. Parents or other family members can invest in a self-invested personal pension (Sipp) for a child, up to a maximum of £3,600 a year – or £300 a month.

Thanks to the tax breaks on contributions, this means actually investing £2,880 – or £240 a month – with the balance being automatically reclaimed from HMRC. The benefit of compound growth over the long term is key. If you were to invest £300 a month into a Sipp for the first 18 years of a child’s life it would cost you £52,000. Assuming 7% growth and 1.5% in charges, at age 65 the ‘child’ would have an impressive pension pot of £1.8m. And this assumes the child makes no further contributions themselves throughout their working life.

By comparison if they started a pension for themselves at age 25 and invested £300 a month gross, it would cost them a total of £115,000 in contributions and it would build a fund of just £496,000. There is no minimum age so a junior Sipp can be started the day the child is born. Even better, the pension fund is outside the estate for inheritance tax purposes so it’s a valuable exercise if you need to reduce the value of your estate.

Last but not least, if you decide to take the plunge, make sure you give them something to open on Christmas Day… tax-efficiency and compounding will be difficult for small children to understand and your good intentions will not be appreciated until your children or grandchildren are much older.

Article is accurate at date of writing.