Putting aside some money over time to build up a nest egg for your loved ones can be a great idea and it’s important to make sure you’re doing it in the best way you can.
With a cost of living crisis, seemingly ever-increasing house prices and general uncertainty about the future, putting money aside to build up a nest egg for your children or grandchildren is seen as being increasingly vital.
Although the first step is the decision to start building a nest egg, it’s also important to think about the best way to do so to make sure you maximise the money you are putting away and to make sure the nest egg grows in an efficient and safe way.
If you are serious about building up a nest egg, then making contributions part of your current budget is a good way of making sure that you continue to contribute over time. Getting used to thinking of the regular contributions as part of your committed spending, along side your utility bills and mortgage payments, will help you plan the rest of your spending around these commitments. This will help make sure that the contributions continue and the nest egg continues to grow over time.
This can be helped by setting up the payment as a standing order or direct debit (depending on where you are sending the money) so that the transfer is automated and you don’t need to actively remember to make the payment each month.
Making sure the nest egg is set up in the most tax-efficient way will help the long term growth of the pot as the drag from taxes is reduced. The easiest way to help with tax efficiency is to use a tax efficient savings or investment product for the nest egg. Considering tax efficiency can help you get the most out of the savings you’re putting aside.
A Junior Individual Savings Account (JISA – the children’s version of an ISA) is a popular option as it allows for tax free growth of savings or investments within the JISA. A JISA is discussed in more detail below.
Other alternatives are to use an investment account within a trust to make the most out of a child’s tax free allowances for income tax and capital gains tax or to set up a pension, which is tax efficient but has drawbacks with the age of access. Both an investment account and a pension for a child can be a great solution for tax efficient savings but they come with some complexity and risks. If you would like to discuss these with a Financial Advisor then please get in touch, we are Financial Advisors in Bristol and are always happy to discuss efficient ways of building a nest egg for your children or grandchildren.
There is also the ability to gift to a child or grandchild and have the gifts not be eligible for Inheritance Tax (IHT). Each year you can utilise the IHT Annual Exemption to give away a total of £3,000 worth of gifts without them being added to the value of your estate. You can give money or gifts of up to £3,000 to one person or split the £3,000 between several people. If any of this annual exemption is unused then it can be carried forward to the next tax year – but only for one tax year. The tax year currently runs from April 6th to April 5th of the following year.
In addition to the IHT Annual Exemption, there is also the Small Gift Allowance. This allows you to give as many gifts of up to £250 per person as you want each tax year, as long as you have not used another allowance on the same person.
Compound growth is very valuable when it comes to growing your money over time. As your pot grows it will generate income (interest or dividends) which gets added to the balance and will in the future receive its own income in future years, building up year and year and compounding. So for savings, it’s the interest on the savings calculated on both the initial principal and the accumulated interest from previous periods.
When saving for a long-term goal, time matters. Compound interest is critical for growing your money over time, as it builds interest on interest. Compound interest works best when you save consistently and as much as possible. Starting early will allow you to take advantage of its power. When saving for a long-term goal, time matters and it can help to start early.
The Junior ISA or ‘JISA’ is the first port of call for most people in the UK when considering savings for a child or grandchild. This is due mainly to the fact that any income or capital growth is free from tax and there are a wide range of providers offering JISAs.
Like normal ISAs, JISAs come in a few forms, with a Stocks and Shares (or “Investment”) JISA or a Cash JISA. Cash JISAs do usually offer interest rates that tend to be better than normal savings accounts, although the difference isn’t significant and the general Cash ISAs will offer rates pretty similar to the regular savings rates (although the benefit of having the savings in the Cash ISA is that the interest will be free from income tax). At the time of writing the top easy-access Cash ISA* was offering 2.5% interest. However, there are Fixed Rate options if you want to lock your money away that can pay higher rates and it’s always a good idea to keep an eye open for any niche products that may offer better rates.
A Stocks and Shares JISA does not offer a guaranteed rate of return like a Cash JISA, but will have the benefit of allowing you to hold investments in the JISA, and allow them to grow tax-free and generate tax-free dividends. Because the time horizon of a child will generally be pretty long (if you start saving for your children from birth then you have an 18-year investment period for the pot to grow), it is often suited to investing in equity markets which historically have shown to deliver greater long-term returns than savings accounts. However, it is not so straightforward to open a stocks and shares JISA and there are many more factors to take into account, including understanding the greater risk involved and where the money should be invested; talking to a Financial Advisor who deals with investments can be a good place to start understanding if an S&S JISA is right for your situation.
The current limit on annual contributions into a JISA is £9,000 per annum*. The child can gain control of the account when they’re 16, but cannot access the money until they turn 18.
If you have decided that cash savings are the best place for your nest egg then making sure that it is in the best savings account for you is key.
Rising interest rates around the world has resulted in many savings account paying much higher savings rates. The rise in rates is due to the Bank Of England* (BofE) trying to tackle rising inflation, and as a result, the Bank of England (BoE) increased its base interest rate several times recently. As the BofE will likely change rates again in the future, regularly reviewing the interest your savings are earning and what the other options are can make sure you’re getting the most out of your contributions. Shopping around for a savings account that’s right for you and provides a competitive interest rate can make your savings work harder. Over the years of putting money into a nest egg, even a small difference in the interest rate can have a big impact over time.
A key decision when building a nest egg for your children or grandchildren is whether to put the money into a savings account or to invest it.
Historically, over longer time periods, investing in the stock market usually outperforms saving in a current account or savings account (but there’s no guarantee). The younger the child or grandchild is, then the longer they have to grow their nest egg, the longer the potential investment horizon, and the more likely that investing will outperform saving.
Alternatively, if you have a short timeframe (for example your child is 16 already and will soon be an adult with a need for the nest egg in a couple of years), then the volatility and risk of the stock market may mean it’s more sensible to save instead of investing. There is no set rule on the point at which investing becomes more suitable than saving (and a combination may also be a good option) as there are a lot of factors involved in making the right choice, but generally, a time period of fewer than 5 years is seen as too short to invest.
While money held in a savings account earns guaranteed interest, if it is lower than the rate of inflation then in real terms, the value of the savings pot is falling and not keeping pace with the rising costs that the money will be used for. Over a long time period, inflation can have a serious impact on the value of savings.
Having taken the important first step of deciding to set up a nest egg, the next step is to make sure it’s done in the best way possible so that you have the best chance of building up a decent size nest egg for your loved ones.
Setting up contributions that are built into your budget and regular, will help make sure that you continue to contribute over time; even if it is just a small amount every time. Starting early and using the power of compound growth will help boost the final value of the pot, as will making sure it is in the most tax-efficient place, such as a Junior ISA.
Investing can be considered instead of a savings account, but care needs to be taken as although there is the potential for greater growth, there are more risks, complexities and costs to consider. It may be wise to contact a financial adviser for a free consultation to discuss things a bit further if you are considering investing and would like to find out a bit more.
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