Four birthdays that could be worth a million pounds

My daughter was born in April this year. I would like to tell you that I spent those first few hours gazing at her in quiet wonder.

What actually happened is that, while my wife was busy with the important job of giving our daughter her first feed, I was in the chair next to the bed with my phone out, opening her a pension. Working in financial planning really does sort your priorities out.

In my defence, I did at least wait until she had a name.

There is a serious point buried in there somewhere, though, and it is one that comes up a lot. Usually from grandparents rather than parents, and usually in a slightly apologetic way. The baby has arrived, the nursery is already full, the toys will be outgrown by Christmas, and someone would quite like to know whether there is anything they could do with the money that might still matter in fifty years' time.

There is. And most people have never had it explained to them properly.

You can open a pension for a child on the day they are born.

How it works

Anyone under 18 can have a pension, opened and managed by a parent or guardian until their eighteenth birthday. Because a baby has no earnings, the maximum contribution is £3,600 a year. But you only pay in £2,880, because the government adds £720 in basic rate tax relief on top. That is a 25% uplift on the money you put in, before it has been invested at all.

Grandparents, godparents and anyone else can contribute. The account simply has to be opened by a parent or guardian, and the £3,600 is the total across everyone.

That is the whole mechanism. What makes it remarkable isn't the tax relief. It's the time.

What four years of contributions could be worth

Let's take a deliberately modest example. A child is born. For their first four years, the family pays in the full £3,600 a year, a net cost of £2,880 each time. On their fourth birthday, the contributions stop. Nobody pays in another penny, ever.

Total paid in by the family: £11,520. Total in the pension after tax relief: £14,400.

Now it simply sits there and grows. Assuming 7% a year after charges, by the time that child reaches 65 the pot is worth around £1,060,000, from a total cost to the family of £11,520.

From four contributions, made before they could tie their own shoelaces. Around a quarter of that would normally be available as tax-free cash, roughly £265,000 on these figures, with the balance taxable as income when it is drawn.

Four years and £3,600 is not a rule, incidentally. It is just a neat illustration. You can contribute for as long as you like, in whatever amounts suit you, as a lump sum each year or as a monthly standing order of £50. We have used four full contributions because those are the numbers that happen to reach that headline million, but the principle works just as well at a fraction of the size. Anything you put in early has the same six decades to grow.

Why not just use a Junior ISA?

It is the obvious question, and it is the right one. A Junior ISA is more flexible, has a much higher annual allowance of £9,000 in the current tax year, and the money comes out tax free rather than being taxed as income.

So let's run exactly the same example, £2,880 a year for four years at the same 7% growth, and compare the two side by side.

Two things stand out. The first is that £212,000 gap at 65. That is purely the tax relief, left alone to compound for six and a half decades. £2,880 of free money became a fifth of a million.

The second is the row that really decides it. At 18, the Junior ISA belongs to your child absolutely, and they can spend all of it on whatever an eighteen-year-old considers essential. That flexibility is genuinely valuable if the money is meant for university, a car or a house deposit. But if the money is meant for their retirement, flexibility is exactly the thing you don't want.

The pension cannot be touched. Not at 18, not at 30, not in a difficult year at 45. That is usually presented as the drawback. For a gift specifically intended to sit untouched for sixty years, it is arguably the entire point.

The cost of waiting

Here is the number that tends to land hardest. Take the same £14,400, with the same tax relief and the same 7% growth, but paid in over four years starting at age 30 rather than at birth.

Identical contributions. Identical returns. A little over an eighth of the outcome, purely because it started thirty years later.

Over a horizon this long, time in the market isn't one factor among several. It is the whole game. For context, the same £11,520 left in cash earning 3% would be worth around £75,000 at 65.

Don't forget about inflation

A million pounds in the 2090s will not buy what a million pounds buys today, and any article that shows you that headline without saying so isn't being straight with you.

In today's money, that £1,060,000 is worth roughly £213,000 if inflation averages 2.5%, or about £155,000 at 3%.

That is a much smaller number. It is also still, in real terms, somewhere between thirteen and eighteen times what the family actually paid in, and a six-figure sum in today's money arriving on top of whatever pension your child builds through their own working life. For most people, this could still allow for a much earlier retirement, or simply a more comfortable one.

Is 7% a fair assumption?

Over one year, no assumption is safe. Markets fall, and sometimes they fall a long way. A children's pension invested in global equities will have plenty of frightening years over six decades.

Over sixty-five years, the picture changes. Globally diversified equities have historically delivered long-run returns comfortably above 7%, and a portfolio with this time horizon can sit through the bad years in a way a five-year plan cannot. Our figures assume 7% a year after charges throughout.

None of which makes it a guarantee. Past performance is not a promise, and your child could get back less than was paid in.

The things to be aware of

They cannot touch it for a very long time. The minimum pension age is currently 55, rising to 57 in 2028 and then tracking ten years below the state pension age. A child born today should expect to wait until their sixties.

It is irreversible, and it is theirs. Once contributed, the money belongs to your child. It cannot be returned if your own circumstances change.

It may not be the first priority. For most families, an emergency fund, protection and your own retirement provision come first. Where money may be needed for university or a first home, a Junior ISA is the better tool. Plenty of families do both.

Rules change. Everything here reflects current legislation and tax treatment, both of which can change over a period this long.

A quiet benefit for the person writing the cheque

For grandparents there is a useful side effect. A £2,880 payment sits within the £3,000 annual gift exemption for inheritance tax, so it leaves the estate immediately with no seven-year wait. Two jobs at once, for families already thinking about estate planning.

So, is it right for your family?

It depends entirely on your circumstances. Whether your own plans are on track, whether the money might be needed sooner, and what you actually want this gift to do.

But if the answer to that last question is "give them one thing they will never have to worry about", then four birthdays' worth of contributions, and then sixty years of leaving it entirely alone, is a remarkably efficient way of doing it.

If it is something you would like to look at for your own family, get in touch.

This article is for general information and is not personal advice. The value of investments can fall as well as rise and you may get back less than invested. Tax treatment depends on individual circumstances and may change. Figures are illustrative projections, not guaranteed, and assume contributions at the start of each of the first four years.