Make your baby a millionaire!

Find out how, by contributing even a little each month you could build up a healthy lump sum for child.

Some friends of mine have just had their first baby, and understandably besotted they are, too (I have three little monkeys, hence the incredible amazement at every gurgle has slightly dimmed for me!).

While they are not struggling, they aren’t rolling in cash either, and in time-honoured tradition they wish to start saving for their child. But rather than using a savings account or Junior ISA, they are looking into pensions.

Pensions for kids

A pension, I hear you say? But what’s the point – wouldn’t it be better to provide a lump sum when they need it, when they’re 18?

Well it really depends on your outlook. Lump sums to help kids start off in life are great and could really help a young person to buy a car, contribute towards a deposit on a flat, or help pay university costs.

But as a population we are living longer, so saving for the long term could provide your child with valuable financial security in later life. Plus, if the money is in a pension an exuberant teenager can’t fritter it away!

And the best bit is, with tax relief and the miracle of compound returns you can really stretch that pound.

Fancy making your baby a millionaire?

Research carried out by Alliance Trust Savings reckons that stashing away £83 per month into your child’s SIPP from birth could give him a pension pot containing over £1 million, by the time he hits 65.

Tax relief plays its part in that sum, as it assumes every £83 payment would be topped up by HMRC with basic rate tax relief, resulting in a gross contribution of £103.75 per month (even non-taxpayers are entitled to basic rate tax relief, where contributions up to £2,880 will be topped up to a maximum of £3,600).

The growth rate is assumed to be 7% AER, and annual charges and fees have been deducted. And let’s face it; a pension pot containing £1 million is not to be sniffed at!

Saving for a lump sum at 18

But what if you aren’t so hung up on hitting the wondrous £1 million mark? What if you just want create a lump sum for your child when he reaches 18?

Well, let’s go back and use my friend’s baby daughter, Emily, as an example. I’ve done some number crunching to see how much she could yield when she is 18 with different monthly contributions, and different interest rates. And as she received £200 from various relatives I have included this as an initial sum:

Table of monthly contributions over an 18-year period and their potential yields. Initial investment of £200 is included.

*Taxes, fees and charges have not been deducted

As you can see, the results are quite interesting. Should my friends be fortunate enough to be able to stash £150 away each month, Emily could be potentially be looking at a whopping £64,000 at the age of 18. It obviously won’t be worth as much then as it is now, but should still help to cover some bills.

But encouragingly, if they could only save £25 per month on her behalf, she could still have over £11,000.

Interest rates matter!

Most apparent is the realisation that interest rates really do matter – if Emily earns 7% rather than 3% she could have almost 50% more in her account at 18!

A little extra

But what if you can stash away a little more?

Emily’s grandparents have generously promised to give their new granddaughter £150 each year on her birthday. How could this affect the final figures?

Let’s take a look at the £25, £100 and £150 monthly contributions.

Table of contributions over an 18-year period (including £200 initial investment and extra £150 annual payment).

*Taxes, fees and charges have not been deducted

Contribute £25 monthly, and with the addition of her birthday money Emily could now have nearly £17,000 at 18, as opposed to just over £11,000. Or if they saved £150 a month, £70,500 as compared to £64,000. It certainly makes you realise that it can be well worth adding any extra birthday money for your child.

Where to stash the cash?

One thing I haven’t gone into is where this money is going – and unless you know something I don’t it is probably not going to be a savings account (although the Halifax does have a Children’s Regular Saver paying 6% for one year!).

Personally, as shares have tended to outperform cash over the long term I’d be plumping for a cheap index tracker (possibly via a Junior ISA) as the best way to hopefully maximise the return, but other options such as bonds can be good alternatives. Find out more in How to build a nest egg for your children.

And while investing can be risky business, remember with 18 years to go, Emily has plenty of time to hopefully ride out any ups and downs in the stock market.

Of course, the more we can save each month for our kids, the better, and if we can make our kids millionaires at 65 that’s great.

But squirreling away whatever you can afford, no matter how small will all help to leave him or her with a healthy nest egg to either re-invest, or use when the time comes.

Happy saving!

More: How to save when you've got no money | Give your child £118k tax-free