We all want the best for our kids. But we all have a different idea of what that means. Some people believe in leaving their children with very little money, so that they have to make their own way. Others want to set their children up so that they have the freedom to make life choices that aren’t solely focused on money.
Given that you’ve decided to read this article, there’s a good chance you’re in the second camp. Luckily, with some forward planning, you can give your children financial freedom for a surprisingly small sum of money. That’s not an exaggeration by the way. Just £30k can give your kid over £5 million by the time they hit 65. Let's show you how.
Money is one of, if not the, major drivers of the decisions in our lives. We choose a career based at least partly on how much we could earn, we choose where to live based on what we can afford, we tend to spend our time with people of a similar socio-economic status as us and even our hobbies are influenced by how much we can afford to spend on them.
This has created a society where many people aren’t able to follow what they truly want to do. They have to make compromises. Give up on dreams. Accept their lot in life.
Money changes that.
Without wanting to get too deep in the philosophical weeds, providing a funded retirement for your children allows them to live their life completely on their own terms. They can make decisions that aren’t influenced by the level of pension matching or bonus structure from a corporate job.
If they want to, it will allow them to pursue excellence in any field, regardless of how well it pays. Maybe they want to become a world class athlete, an academic, a professional musician or they want to build the world’s next big startup. Without the nagging doubt of “how will I fund my future,” they can go after any of those things.
And if they do want to climb the corporate ladder, they can do it by choice. They can make bold career moves and stand out from the crowd without worrying that a misstep or a redundancy could ruin their financial future.
Looking at the situation from another angle, they’ll also have the freedom to spend more time with their children. To go on big family holidays together. You might even be invited to some of them.
In short, it gives them choices. Isn’t that what we all want for our children?
Lastly, it’s good for you too. Many parents want to leave a legacy behind when they pass away. We’ve seen many clients hold back from spending their own money in retirement, because they’re worried about eating into their children’s inheritance. We’ve seen parents make career and life choices based on being able to financially secure their children's future, rather than what they actually want to do.
Setting up a separate pot removes that dilemma. You can live your life how you want to live it and spend down every penny in your retirement if you want to. You can do that whilst staying safe in the knowledge that you’re still leaving behind a life changing sum of money for your kids.
To properly understand how you get to such a big investment number, we’ve got to start by explaining compound growth. I know you have heard of this idea before but let us explain this step by step, in numbers to fully appreciate what it really is.
Compound growth is what happens when you allow your investment returns to stay in your portfolio and snowball. It means that over time your pot gets bigger, and the growth accelerates.
Say in year 1 you invest £10,000 and achieve a return of 10% each year. That equates to £1,000 in gain. Next year, assuming you re-invest your gains, you have £11,000 invested which means the same 10% return gives you £1,100 gain. Now you have £12,100 invested which nets £1,210 as a gain and so on and so on.
Your balance is increasing each year with your investment returns, and because the balance is increasing the gains in pounds and pence (or dollars and cents) each year increase as well.
A financial rule of thumb that’s often used is the rule of 72. This is an equation that allows you to work out how many years it will take you to double your money. You simply divide the number 72 by the rate of return, and you get the answer in years.
For example, if you achieve a return of 10% the equation would be:
72/10 = 7.2
So if you achieve a return of 10%, you’ll double your money roughly every 7.2 years.
72/8 = 9
If you only get an 8% return, it will take you 9 years to double your money.
Ok so how do you actually do it? The key to compound growth is time. The longer you have to invest for, the bigger and crazier the numbers get towards the end of the time period.
To show how this works, let’s consider Rebecca and Andrea, who’ve just welcomed to the world baby Olivia.
Rebecca and Andrew decide to invest £3,600 per year into an account, or a number of different accounts, for Olivia. This number is significant because it’s the amount that a non-worker (like a baby) can contribute to a pension in the UK. There are tax benefits to using this type of account, but there are lots of different types of wrappers that could work just as well.
The most important part for Rebecca and Andrew is that they are using an account that is tax free. It’s the type of thing we do for plenty of clients at Rosecut.
So, they contribute £3,600 each year into an account for Olivia, but they decide to stop when she’s 10 years old. In total that means they’ve contributed £36,000 into the investment (though in a pension it would only be £28,800 actual cash they put in because of the tax relief the couple will receive - based on current tax rules).
Because the investment timeframe is 60+ years, they can afford to take a high risk approach to the investments, and so we’ll assume an average net return of 8.50%.
How much do you think little Olivia will have in the pot by the time she’s 65? We’ll save you the suspense.
That’s right, over £5 million. That’s a hell of a legacy to leave.
Think age 65 is too far and Olivia can make do with less at a younger age? She will turn into a millionaire by the age of 45.
If you are curious about what else Rosecut will say about your own financial future, please access our free financial projection here.
Please note that this is not a financial advice and it does not take into account individual circumstances. Please also contact a professional advisor prior to any decision making.
The value of an investment and the income from it can go down as well as up and investors may not get back the amount invested. This may be partly the result of exchange rate fluctuations in investments which have an exposure to foreign currencies. You should be aware that past performance is no guarantee of future performance.