Individual savings accounts (ISAs) aren’t just for adults. You could use tax-efficient investments to make your child a millionaire within a few decades.
There are “generous tax breaks” when investing on behalf of your child, said MoneyWeek, with parents able to earn returns on money put aside for their loved ones tax-free in a junior ISA (JISA) and pension.
“Diligently saving for your child from when they’re a newborn baby until age 18… could turn your child into a tax-free millionaire before they hit 40,” the financial website said.
By starting to save early, added Money Helper, you can put your children on the path to a solid financial future.
How a junior ISA works
Similar to an adult ISA, a JISA can be set up to earn returns on savings or investments tax-free for a child. There are two kinds of JISAs – cash, or stocks and shares – and they have their own separate annual allowance, currently £9,000. Junior cash ISAs offer parents higher interest rates than other savings vehicles, said This Is Money, but “investing is more likely to result in better returns”.
Only a parent or legal guardian can open a JISA, said The Money Edit. Once it is set up, anyone can make a contribution, so grandparents or uncles and aunts can get involved. The money inside the JISA belongs to the child. They can take control of the account once they turn 16 but the money cannot be withdrawn until they reach 18.
You can set up a stocks and shares ISA with a financial adviser or DIY investing platform. “When weighing up the right one”, This Is Money advised, you should check that it includes junior ISAs, and make note of “administration charges and dealing fees, plus any other extra costs”.
It’s also important to consider the limitations of a JISA. The cash you put in is locked away for up to 18 years, which means it cannot be withdrawn should you need it for other expenses. And while ideally your “hard-earned savings will go towards something sensible such as a deposit for a property or on tuition fees”, said This Is Money, ultimately you cannot control what your child does with their account when they gain access to it.
Consider a child’s pension instead
If you want to take a really long-term view, said The Times Money Mentor, you could invest for your child’s pension.
Starting your child’s pension from a young age could make a big difference, the financial website added. “Even if you save small amounts, over many decades it could grow to a substantial pot over time.”
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Up to £2,880 can be contributed to a pension each year for a child, and like a normal retirement account, it can be accessed from age 55. While most children do not have to pay income tax, said MoneyWeek, they will still benefit from tax relief, which is worth up to £720 a year.
“So, if you pay the full £2,880 into a child’s pension,” the website explained, “…then with tax relief added on top, a total gross amount of £3,600 can be put aside in a child’s pension each year.”
Making a millionaire
Making use of both a JISA and a pension for your child could set them on the path to becoming a millionaire.
Squirrelling away the maximum JISA and pension allowances over 18 years could turn a £213,840 outlay into £1,021,765 before your child is 40, said MoneyWeek, “thanks to the power of compound growth and tax relief”.
The exact calculation breaks down like this: over 18 years £162,000 would be put into a JISA, and £51,840 into a pension. The latter would then be topped up with tax relief from the government, adding £12,960 and bringing your total pension contributions to £64,900.
Assuming a 5% annual return over 18 years, the combined pots would be worth “an impressive £376,688”, said MoneyWeek. If it was then left untouched with no further contributions or withdrawals and earned the same returns, the portfolio would reach £1m by the time the child reaches 37.
Of course, utilising the entire JISA allowance will be hard for many people, especially during a cost of living crisis. But you can invest as little as £25 a month in a junior ISA, Sarah Coles, head of personal finance at Hargreaves Lansdown, told the i newspaper.
If you could manage to increase this monthly sum to £55.50, “you’d end up with a healthy pot of £18,000 by the time your child hits adulthood”, Coles said.
Marc Shoffman is an award-winning freelance journalist, specialising in business, property and personal finance. He has a master’s degree in financial journalism from City University and has previously written for FT Adviser, This Is Money, the Mail on Sunday and MoneyWeek. This article is based on information first published on The Week’s sister site, The Money Edit.