Answer: a pension. Bear with me, because this is not the normal argument about the value of saving for retirement, even if all that stuff is true, and what I would normally lead with in an article like this.
Imagine for the sake of argument that your grandchild is born in January next year. Given you are organised, you put £3,600 (the maximum amount) into a pension when they are born. You then leave it in there, knowing that your grandchild will not be able to touch it until they are at least 57.
A pretty terrible present so far, right? Absolutely no fun. Strike me off the guest list for your next party.
Wrong. Because although this sum of money will probably stay locked up for at least half a century, its effect first starts to be felt when your grandchild is in their 20s.
Assume this putative grandchild gets their first proper job around the age of 21. They will want to spend what little disposable income they have. The metaphorical angel on their shoulders will tell them to save for a house and pension. The proverbial devil will suggest they go on holiday, buy those concert tickets, and go out for all the bottomless brunches and avocadoes on toast they can manage. Unless they live an Aristotelian life of virtue, they will give into those temptations.
But it is okay for them to enjoy their youth because they have their pension working in the background! If you invest that £3,600 and assume a reasonably achievable average growth rate of 5% per annum over the long term, that initial £3,600 has turned into £10,029.47 by the time they are 21. You have effectively given them a £10,000 head start on their pension, and they have not had to lift a finger for it!
As a result of your generosity, they don’t have to set aside money from their first pay packets for something boring. They can enjoy the greatest asset of all time – youth – and still be responsible.
If the £3,600 never existed, they would have to invest £10,000 to get to the same place in pension savings. What can £10,000 buy you when you are in your 20s? Well, one of the following, depending on taste:
- Countless nights out in London, 50 on a conservative basis, even if you push the boat out
- 34 all-in city breaks across Europe (based on research from Post Office Money and assuming a two-night stay in three-star accommodation)
- Almost six years’ membership to Soho House, a 21st century members club
- Four and a bit years’ membership to Third Space, a ridiculously expensive, but extremely nice, London gym
- A six month round the world trip
This is the benefit of starting early, and it is surprisingly powerful. By the time you reached 70, that initial £3,600 would be worth £109,535.18. That is again assuming an average 5% return a year – not at all unreasonable over the course of seven decades.
Now, you could argue that you should not invest in a pension for someone so young. It might be better to invest the money for a house deposit; in which case you would not invest in a pension. There is also an argument about whether the money in a pension would stay tax free over the course of 70 years, especially given how much the rules have changed over the past two decades. But my real point here is to highlight the value of long-term investing, especially the compounding of returns, and how it can help people throughout their lives.
Ultimately, this is all about legacy. If you want to help your grandchildren or children, there are few better ways than setting money aside. Money you would set aside for retirement can be ploughed back into their retirement, creating a virtuous circle of financial safety.
So, invest for them. They are only young once. Let them have some fun.
Only a minority of Self Invested Personal Pensions (SIPPs) providers will let you withdraw your pension before the age of 57. Even if you are allowed, however, HMRC will tax it the withdrawn funds at 55%