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Could the bank of mum and dad fix the pension crisis?

The Bank of Mum and Dad is apparently one of the UK’s largest lenders but is now the time for it to become a savings bank too? 

Even before the pandemic, the UK faced an apparent pension funding crisis with many people not saving enough for retirement and now, with the threat of an increase in joblessness with under 25s looking to take the biggest hit, parents and grandparents may once again need to step in to support their children. 

For many parents and grandparents, rather than lending the money, or passing it on when they die, regular gifting out of income could be the answer. By starting early, it is staggering what a difference you can easily make to their financial future.

A millionaire baby

If parents and/or grandparents were to contribute towards savings of £9,000 a year in a Junior ISA for those children who are eligible, assuming a return of 5% per annum, at 18 years your child could be sitting on a tax free nest egg of £275k!1

If, however, at age 18 they were to leave their Junior ISA funds in an ‘adult’ ISA and leave that until retirement, at age 55 they could have a small fortune of almost £1.7m! 2

This is all without your child adding anything more to the original investment themselves. This figure shows the power of compounding, as the amount invested over the 18 years would have been £162,000 in total. 

If the older generations are worried about their children squandering money before they are responsible enough to use it wisely – or wise enough to use it irresponsibly – they could instead contribute into a pension for their child so that the money can’t be accessed until the age of 55. 3

Although it’s unlikely their child will be a taxpayer when they are young, even where the child/grandchild has no earnings at all, the pension contributions will receive basic rate tax relief on total contributions up to £3,600 per annum gross from the parents/grandparents.
 

Small amounts that make a big difference

For a maximum gross contribution of £3,600 per annum until the age of 18, this will cost the parent just £2,880 net per year (£51,840 in total) and the government will add tax relief of £720 per year (£12,960 in all). These smaller amounts may well be within the reach of many families.

As above, assuming a growth of 5% until the age of 55 – and assuming the parents stop contributing at age 18 and the child makes no further additions, they could have access to a pension fund of £669k. 4

Remember this comes from a net contribution of just £51,840! 

Summary of parent contributions

Parent contributionMoney in - for 18 yearsMoney out - at age 55
Junior ISA  
Parent £162,000 
Growth at 5%£1,503,480 
  £1,671,480
Pension   
Parent £51,840 
Government£12,960 
Growth at 5%£603,792 
  £668,592
  £2,340,072

There are many ways you can support your children financially over their lifetime but putting money aside for their retirement takes away a huge burden.

It may seem like a crazy idea when they’re just a baby but having money invested for the longer term and with the long term effects of equity markets, potentially this means they wouldn’t need to save a penny themselves in order to enjoy a comfortable retirement.

And with tax benefits on pension contributions, this becomes even more affordable for many.

In reality they will most likely make their own and employer’s contributions at some point which would enable them to consider retiring earlier with the benefit of more time with family and friends in their old age. What an amazing gift to give to your child!

What about making their own contributions?

When the child is old enough to make their own contributions to a pension, assuming a 5% personal contribution from age 30 plus matching employer’s contributions for someone earning £30,000 a year, that’s an additional £147k added to the overall pension pot over 25 years. 5

Summary of child contributions

Child contribution Money out - at age 55
From age 30 to age 55 assuming income of £30,000

£125 pm gross

(£100 child plus £25 tax relief)

£37,500 total 

£73,529
Employer contribution £125 pm gross (£37,500 total)£73,529
   
 TOTAL £147,058

So the total pension at age 55 is over £815k! Plus the JISA/ISA investment and child contributions, that's a combined total of £2,487,130.

Even in the awful event of an early death the whole pension sum could be free from tax to any nominated beneficiaries.

As defined benefit pensions have all but disappeared, many parents will be aware of how little has been saved for their own retirement and just how important it is to put money aside.

The financial pressures on younger generations, with high education costs, expensive housing and the threat of unemployment mean that saving for retirement early in their lives may simply be unaffordable.

It’s worrying then that increasingly children are relying on an ‘inheritance’ to help them in later life. But maybe parents can provide that ‘inheritance’ before they die.

Cash Flow forecasting - the key to planning your retirement 

Cash flow forecasting - or planning ahead - will allow you to start planning with the end vision in mind for both you and your loved ones, to see in pictures and in numbers what is needed and what is achievable in your financial future.

It will create a personal plan with various different scenarios around which you can make sensible decisions. It’s a bit like your personal financial crystal ball!

If you are ahead of the curve you might have a luxury set of issues to deal with (better retirement, ability to spend more, retire earlier, or take less risk with your investments)

If you are behind the curve, it can demonstrate the hard actions you need to take (work longer, save more, spend less, take more risk)

The Private Office is currently offering all those with £100,000 or more in savings, investments or pensions, the opportunity for a cash flow forecasting retirement review worth up to £500 for free. Do you know when you can afford to retire? It could be sooner than you think. Find out more information.
 

Contact us

Please note: The Financial Conduct Authority does not regulate Tax Advice, Estate Planning or Cash Flow planning. The value of investments and the income derived from them can fall as well as rise. You may not get back what you invest.

References 

The initial numbers are all in today’s money. If we were to assume inflation of 2.5% over the next 55 years the inflation adjusted amounts are in brackets.

  1. £274,851.04 (£219,496 inflation adjusted)
  2. £1,671,480.99 (£522,615 inflation adjusted)
  3. Under current pension rules. 
  4. £668,592 (£209,046 inflation adjusted)
  5. £147,059 (£103,025 inflation adjusted) assuming flat salary of £30,000 for 25 years.