Younger generations face financial challenges such as high university fees, getting on to the property ladder and less generous pensions than their grandparents have. So parents, and increasingly grandparents, are offering younger members of the family financial assistance.
"Parents could have their own financial challenges so may not be able to help their children as much as they would like without impacting on their own lifestyle and financial security," says Patrick Connolly, certified financial planner at Chase de Vere. "By contrast, many grandparents are benefiting from good-quality pensions, meaning they have guaranteed and secure income. And it is older age groups that have reaped the biggest rewards from the spectacular price rises in UK residential property in the past decade. So grandparents may be in a position of financial security."
In some cases, grandparents are making living inheritances by passing on assets while they are still alive rather than as a legacy. Or they are skipping a generation by passing on assets directly to their grandchildren rather than children.
However, a less complicated way to help grandchildren is to invest on their behalf from when they are at an early age. Doing this means the investments will benefit from compound interest over a long time.
"A huge portion of the growth in equity holdings comes from reinvesting dividends, rather than share price appreciation," says Sacha Chorley, portfolio manager at Quilter. "Younger people investing for the future without the need to generate income will therefore have a fantastic opportunity to benefit from this compounding effect."
If you keep the money invested, rather than spending the interest or investment returns, over one year an investment returning 5 per cent, net of fees, will pay £50 on a £1,000 deposit. But after two years the investment will deliver £52 because the 5 per cent return is applied to the larger balance of £1,050. The longer you invest without drawing on the money, the more your investment will grow. So if you invest on behalf of a child they will get the most benefit.
For example, a one-off sum of £2,880 with a tax rebate on top invested in a pension when your grandchild is first born could grow to more than £52,500 by the time they reach age 55, assuming average growth of 5 per cent per year after fees. This could grow to as much as £85,800 by the time they are aged 65, according to Andrew James, chartered financial planner at Tilney Group. If you invest £3,600 (made up of your £2,880 contribution and the tax rebate of £720)each year between the child's birth and when they turn 18, even if you don't pay more into the pension this could grow to £1m by the time they are age 65.
Investing for a grandchild over long-term periods means you can invest in higher-risk, higher-reward growth investments, as they will have time to ride out and recover from rough periods in the market.
"Asset allocation [might] involve greater exposure to equity markets, in particular emerging or frontier markets and long-term growth stocks," suggests Mr Chorley. "In addition, alternative asset classes like infrastructure or unquoted private companies can provide long-term growth opportunities in exchange for taking on a degree of liquidity risk that may not otherwise be appropriate for investors with a shorter investment horizon."
Investing in a pension for your grandchild
You could invest for your grandchild in a pension, for example, a junior self-invested personal pension (Sipp) or a stakeholder pension. The money in a pension cannot be accessed by the child until they are in their 50s, which means the investment will have several decades to grow and benefit from compounding. And contributions into a child's pension get tax relief. The maximum amount you can invest into a child's pension is £3,600 gross per child, per tax year. This includes 20 per cent tax relief, so you only put in £2,880. Investments held in a pension grow free from UK income and capital gains tax (CGT). And any gifts you make into a child's pension are likely to be exempt from inheritance tax (IHT) so won't count towards your estate's value.
"The beauty of the pension is that it takes the money out of temptation's way as these can only be accessed from age 55, and from 2028 age 57," says Emma-Lou Montgomery, associate director for personal investing at Fidelity International. "If grandparents invest £240 a month, with the government boost £300 is invested."
Mr James adds: "There are so many financial calls on younger generations – with housing costs being higher than for previous generations and the need to pay off student loans, so there's a huge burden on individuals in those early years when they need to put money into a pension. But if grandparents give them a head start on retirement planning it gives them a boost."
However, because your grandchildren will not be able to access this money until they are in their 50s, they cannot use it for earlier financial needs such as buying a house. And as retirement age is likely to rise in future, the age at which they can access the money is likely to be even later. So many financial planners think grandparents should invest in a junior individual saving account (Isa) before they put money into a pension.
Junior Isas
A Junior stocks-and-shares Isa allows you to invest money on behalf of your grandchild tax-efficiently. Although the account has to be opened by a parent or legal guardian, grandparents can add money to it. Currently the annual Junior Isa allowance is £4,260.
Old Mutual Wealth says that investing the maximum contribution of £4,260 into a stock-and-shares Junior Isa for 18 years could add up to more than £150,000, assuming the Isa allowance rises annually by 2 per cent and the investments grow on average 4 per cent a year net of fees.
Returns from regular saving into a junior Isa
| Monthly saving amount | £70 | £90 | £344* |
| Total amount saved in 18 years | £15,120 | £19,440 | £74,304 |
| Value of savings after growth in 18 years | £21,535 | £27,766 | £106,600 |
Source: Fidelity International. Based on 5 per cent growth per year, 0.75 per cent annual management charge and platform service fees. *Current maximum contribution permitted.
But a Junior Isa is transferred into the name of the child when they turn 18, giving them full access to the money. So although it can be a good way to meet earlier life expenses many parents and grandparents worry about putting a substantial amount of money into a young adult's hands.
Rachael Griffin, tax and financial planning expert at Old Mutual Wealth, says: "If parents [or grandparents] want to keep control of the money they could use their own Isa allowances before they invest in a Junior Isa. Contributions made into an Isa in [your own] name can still be used for the child, but the parent [or grandparent] would retain control over when and how the money is spent."
At present you can invest up to £20,000 per tax year into an Isa.
But Danny Cox, chartered financial planner at Hargreaves Lansdown, says in his experience most young people who receive control of a Junior Isa at age 18 behave responsibly with the money. Hargreaves Lansdown found that more than 90 per cent of Junior Isas on its platform remain open 12 months after they have been handed over to the child on their 18th birthday. And a third of those accounts have had further contributions made to them since the handover.
Mr Cox says: "It shows the common perception that when people get money they blow it on fast cars and an extravagant lifestyle is mistaken."
Pensions vs Isas
Whether you opt for a pension or Junior Isa comes down to when you would like your child/grandchild to receive the money, and how much you can afford to invest. In the current 2018-19 tax year you could invest up to £7,140 per child if you fund a Junior Isa and a child's pension.
"If you can fund both [a pension and junior Isa] you've covered off both the medium and long term," says Ms Montgomery. "If you want to see the child put the money towards the cost of, for example, a wedding, house purchase or university, a Junior Isa is a better option. But if you are investing for the much longer term a pension would be a good idea. You won't be around to see the child enjoy it, but it will be a nice legacy to leave."
