Pension Funds for Children: Harnessing the Value of Compounding

A gift that grows: the case for children’s pensions

When you think about your children or grandchildren, and all the potential they hold can be exciting! And as a parent or grandparent, it’s natural to want to support this. Gifting to the next generation and helping set them up for success, can be a hugely rewarding aspect of financial planning. There are a lot of options available to you, and the way you choose to gift can have a lasting impact, both financially and emotionally. 

One option that is often overlooked is setting up a pension. While it might seem strange to start a pension for someone who hasn’t taken their first steps yet, the long-term benefits can be extraordinary. It can harness the time value of money, meaning a small contribution can grow into something far more substantial. We explore what this means, and why this can be such a valuable gift.

How children’s pension plans work

A pension plan can be opened for a child by a parent or guardian from the day they are born until the age of 18. Once opened, anyone can contribute to it. The parent or guardian will be in charge of making any decisions regarding ongoing management of the plan (including any investment decisions) until the child reaches the age of 18. At this point, the child will automatically become the decision maker for the pension. However it is important to note that like most pensions, they will not be able to access the pension funds until they reach the Normal Minimum Pension Age (NMPA), which will rise from 55 to 57 in 2028.¹

Contribution limits and tax relief explained

Based on the current rules for the tax year 2025/26, a maximum of £3600 can be contributed to a child’s pension plan each year, which includes tax relief. That means that you can contribute up to £2880 and HMRC will top this up by 20%. Where the full contribution of £2880 is made, this is increased to £3600.² That means the maximum investment you could make into an individual child’s SIPP is £51,840 (18x2880). 

For grandparents considering contributing to their grandchild’s pension, it is also worth noting that a payment of £2880 falls within the annual gift allowance. As such this is can also be a great way to reduce the impact of IHT, whilst also setting up your grandchildren for a fantastic future.

Harnessing the benefits of time through a children’s pension plan

Although it might seem like a forward planning taken to extremes, having an investment horizon that could span 50+ years means even small investments can grow into an impressive lump sum. This is because of compounding. Compounding means that the reinvested returns earned by the pension themselves earn returns the next year, and so on.³ This creates a snowball effect as they grow, because you are earning on both your initial capital invested, and the returns you have already earned. 

If you invest £10,000 into an account and it generates an annual return of 5% (after charges), you will see an additional £500 added to your account which would be worth £10,500 after the first year. In the second year, you earn returns on the total amount of £10,500, the original £10,000 and the £500 generated during the first year. If the annual rate of return (after fees) remains at 5%, your account would be worth £11,025 after the second year. In subsequent years, continuing to assume that you earn a positive rate of return after charges, the same principle applies. As such by leaving the funds invested, your money grows more quickly. The longer you leave your money, the more powerful compounding can become. However, you should remember that investments can fall as well as rise and you could get back less than you invest. Additionally, inflation will impact the real value of your money and as such the spending power of your money in the future will be lower than it was today.

Looking through an example of how this could play out in the case of children’s pensions can give you a sense of the compounding opportunities that could be available.

Case study: How early contributions can grow over time

Anna’s grandparents decided that they wanted to help set her up for long term success and asked her parents to open a Junior Self-Invested Personal Pension (SIPP). They decided to make the maximum pension contribution every year until Anna’s 18th birthday, or a total of £51,840 (18 x £2880). This was increased by £12,960 by tax relief, or an additional £720 per year, bringing annual contributions into Anna’s SIPP to £3600. 

Assuming that Anna’s Junior SIPP delivered an average, annual return of 4% after fees, by her 18th birthday the plan would have grown in value to just over £92,000. And if no further contributions were made, and the SIPP continued to deliver an annual return of 4% after fees, by the time Anna reached the age of 67 the plan would be worth just over £630,000(although it should be noted that because of inflation this will buy considerably less than it would today). That would represent an impressive 12-fold return on a £51,840 initial investment. 

Scaling support: how smaller contributions can deliver meaningful impacts

Whilst an annual investment of £2880 into your child or grandchild’s pension might not be possible for everyone, putting aside a smaller amount can still have a big impact. 

If Anna’s grandparents were only able to contribute a one-off lump sum of £2880 (which is topped up to £3600 by HMRC), assuming 5% return net of fees, after 60 years Anna would have close to £72,000. If they chose to invest this more adventurously and it generated an average net total return of 7% net of fees, it would be worth around £237,100 after 60 years. However, note that investing in a higher risk account is also associated with more downside risk as well, and this should be discussed with your financial planner.

Starting conversations around money and planning

Another benefit of starting a pension for your child or grandchild is some of the conversations it opens up around long-term planning. Whilst compounding, investing, rates of return, tax, and inflation might not be the best bedtime story materials, once they are a bit older this could provide a great opportunity to discuss some monetary concepts and improve their financial literacy. Establishing thoughtful habits around long term financial planning early can have big rewards.  

Conclusion

Setting up a pension for your child or grandchild can be a meaningful way to ensure they are looked after well into their future. However, there are a lot of moving parts at play. As such, speaking to your financial planner about this is a great idea. They will be able to help you navigate the tax implications, what kind of account might best suit your needs, and ensuring your generosity fits within your broader financial plan. 

Case studies in this article are based on an article by Faith Glasgow for ii.

 

This article is designed to provide you with information only. It is not designed to provide you with financial advice. Please seek financial advice if you are still unsure about your options. There may be a charge for this. Remember, tax treatment depends on your individual circumstances and may be subject to change in the future. And the value of investments can go down as well as up, and could be worth less than what was paid in. This information is based on our understanding in October 2025. Aberdeen is not responsible for the information, accuracy and views of external sources.