Ditch presents for investments: how you can gift your child £265,851 for Christmas

As Christmas approaches it’s tempting to do a mad dash around the toy shop to buy for the children in your life. But if you’re adding to the toy mountain they already own or know that they will have piles of presents to open, you might want to gift money instead.

For lots of parents, grandparents or friends it’s easy to default to giving cash, gift cards or just transferring money into a child’s bank account. But if you took a bit of time to invest that money instead, they’d thank you in the long run – and what better way to become the favourite auntie or grandpa than handing them a chunky savings pot when they reach adulthood.

Even the cost of a modest present each year can add up if it’s invested and earns decent returns. Planning to buy the toddler in your life the Duplo Peppa Pig’s birthday house or the Spidey and His Amazing Friends dance ’n crawl Spidey? Both will set you back around £30. If you instead invested that amount every year for the child, from birth, and got 5% investment returns a year after charges, you’d have a pot worth almost £900 by their 18th birthday.

If you were going to opt for a pricier gift, the benefit of investment growth and compounding means you’d have a meaty pot of money to hand over at age 18. An LOL Dolls – OMG House of Surprises or the Lego Bowser Express Train would each set you back around £100. If instead you invested that each year, earning 5% returns a year after charges, you’d be handing the child a pot worth almost £3,000 at their 18th birthday – which is probably more attractive to an 18-year-old than a toy gathering dust.

If you feel like too much of a Scrooge ditching presents altogether, you could just cut back how much you gift and invest the difference. Ditching presents is often easier for younger children – who are more interested in the boxes and wrapping paper anyway. If you make a £100 contribution to your kid’s Junior ISA for their first five years, and then switch to getting them a present, they will have a pot worth £1,094 when they’re 18, based on 5% returns each year after charges.

Giving money can also be a great way to spread the cost of Christmas over the year. Rather than making a lump sum investment, parents or grandparents can set up monthly investing for the children in their life and contribute a small amount each month. If set up from birth, a £100 a year contribution could give them a pot worth £580 after five years, £1,321 after 10 years and almost £3,000 by the time they are 18, assuming 5% returns each year after charges.

At the other end of the spectrum, the Junior ISA limit is a whopping £9,000, and any parent fortunate enough to be able to put that amount away for their child each year would be handing them a £265,851 present on their 18th birthday, assuming 5% returns each year after charges. Clearly not an option for all, but always worth asking the wealthy uncle or grandma in your life.

Source: AJ Bell. Based on investment returns of 5% a year after charges. Assumes one-off investment on year one and no further contributions

Source: AJ Bell. Based on investment returns of 5% a year after charges. Assumes the same investment is made each year

Different financial gift options

If you don’t want to get presents but you’re not sure about investments, you might want to weigh up all the options of what you could give the child in your life. There are pros and cons to each, so you’ll want to consider what’s right for you – and the child.

Gift card: A bit of a halfway house between a present and cash, which lets the person you’re giving it to decide on their own gift. Some people like the fact that because it’s tied to a particular shop people must buy something nice with the money – where with cash they could just put it towards the weekly food shop or energy bill. However, lots of gift cards go unused or get lost. In theory the gift card should be replaceable if you lose it and the buyer still has the receipt – but that involves an awkward conversation with the gift giver that many don’t want to have. Also, if the retailer goes bust, you’re likely to have a very limited period to use the gift card before you lose the money altogether. All-in-all they are inflexible and not an ideal gift.

Cash: In an increasingly-digital world physical cash feels a bit old school – particularly for younger people. It offers flexibility, so children can choose to spend it or save it, but it can’t be used online without first transferring it to a bank account – which could be a hassle for some people. It can also be easily lost along with wrapping paper at Christmas.

Cheque: The main appeal with cheques is probably the nostalgia factor. It also has an advantage over cash as a cheque can be rewritten if lost. But it comes with huge hassle factor – many kids today probably don’t know what a cheque is or how to pay it in. While some banks let you pay it in via their mobile app, others will make you go in branch – which might mean it never gets paid in.

Premium Bonds: There’s a decent amount going for Premium Bonds: you can save as little as £25; they are government-backed, so couldn’t be safer; and you have the bonus that they might make your child or grandchild a millionaire. But the expected prize fund rate has dropped recently, you’ll earn less than a cash savings account, and the bonds you buy could win nothing at all. Once you factor in inflation it means the spending power of your gift will be eroded year on year, particularly if the recipient doesn’t cash the money in for a long time.

Cash savings account: If you want to put money in a cash savings account for a child, you’ll likely need the child’s parents to open the account for you (assuming that’s not you). You should hunt around for the best rate possible, and then make a note to check back on the rate in a year or two, as banks have a nasty habit of slashing the interest on offer and relying on people not moving their money. Cash rates have risen in recent years, so you can get a decent return. But for longer-term savings inflation can eat into your spending power and you might be better off investing. That means if the child is young and a has a long time until they’ll need the money, you should consider investing.

Junior Stocks and shares ISA: It’s probably not going to get yelps of excitement when a child opens the gift, but investing is the ideal long-term place for money, making it a good option for people who are gifting money to younger children. And the pot can build up over the years to be an exciting amount once children turn 18. The downside is that the money can’t be accessed until the child is 18. Similarly, when they reach 18, they take control of the money, which means they could cash it in and go on a spending spree – despite your protests.

Junior SIPP: It will surprise many to know that even non-taxpayers can get pension tax relief, so you can put up to £2,880 into a pension each year for a child and it will be topped up by the government to £3,600. If you paid in the maximum each year until they reached 18, and then didn’t make any further contributions, they would have a pension worth almost £410,000 by the age of 55, assuming 4% annual growth. The fact that the pension is locked up for so long means you can be sure they aren’t going to raid the money but clearly the downside is that this is a very long-term investment that the child won’t be able to benefit from until they are retirement age. Currently, that’s 55, but it’s expected to rise and so it’s impossible to predict what it would be for someone who is a child now.

The tax benefit of gifting

Gifting money is a great way to move the assets out of your estate for inheritance tax purposes. Everyone can pass on an estate worth up to £325,000 free of inheritance tax, and some people are eligible for an additional £175,000 limit if they are passing on their main home. But after that the estate will have to pay 40% tax. If you know you’re going to hit this threshold and can afford to part with money now, moving money out of the estate while you’re alive can save tax in the future.

Anyone can gift up to £3,000 a year, as well as extra amounts when certain people in the family get married, without it being considered for inheritance tax purposes. Any gifts over that amount will be subject to the seven-year rule, which means that if you were to die inheritance tax is due on a sliding scale until seven years have passed.