The eight-day festival of Hanukkah that began Wednesday evening is traditionally an occasion for handing children "Hanukkah gelt” – a nominal gift of cash.
Although the children might be disappointed if they didn't get that gift right away, the money could actually go much further if it was put away toward their pensions. We studied this idea with the help of a top-ranking expert in pension savings and Israel’s largest pension fund, Mivtachim HaHadasha. Rather than dispensing a few coins to the kids during the holiday, the money can be saved starting as soon as they are born in order to significantly boost their pensions 67 years down the line.
All it takes is to open pension fund accounts for the children when they’re born and deposit the Hanukkah gelt into the fund on a regular basis. We chose NIS 140 a month, the amount of the state's child allowance, on the assumption that most middle-class families can get by without dipping into the allowance.
As guidelines, we assumed the money is deposited into a standard pension fund with nearly no insurance component, with the maximum permitted management fee charges of 6% on monthly deposits and 0.5% on the cumulative balance – since the small amounts deposited most certainly couldn’t warrant any discount on the fees.
Putting money aside through a pension fund at this stage has some advantages and disadvantages. The main drawback, besides the steep management fees, is that the deposits aren’t subject to any tax benefits except the capital gains exemption at retirement age since they’re being made on a personal basis rather than through an employer. The main advantage is its simplicity, as deposits can be made via an automatic monthly bank account or credit card debit.
There are other options too like opening up a savings account or investing in a mutual fund or an exchange-traded fund (ETF). However, the interest paid out by banks on savings deposits is negligible, while the monthly purchase of mutual funds or ETFs requires making a separate bank transaction each time and would presumably be much costlier in overall fees. These options also don’t provide any tax exemption on retirement.
So saving through a pension plan seems best in ensuring continuity. The deposits would continue until the age of 18 when the state stops paying the child allowance, but over the following 10 years the balance will keep generating returns – less the 0.5% fee.
When the young adults join the labor force around the age of 28 they’ll start saving towards their pensions through the workplace and transfer the initial NIS 50,000 to NIS 58,000 accumulated since birth – depending on the rate of return in the range of 3% to 3.74% generated annually – into their new pension plan.
Assumptions concerning the rate of return are critical, particularly in the case of youngsters who will be saving for 60 or more years. Compound interest has enormous impact over the space of 60 years and every fraction of a percentage in return could mean a huge difference in accumulated pension savings.
At Mivtachim they point out that the fund’s historical rate of return, more or less since the portfolio of pension funds in the capital market stabilized in the middle of the previous decade, is a net 4% when adjusted for inflation – and that this takes into account the market crash of 2008. In other words, the assumption of a 3% return for the next 60 years is considered at Mivtachim as being overly conservative.
The expert we spoke with, however, is deeply concerned about the current global crisis situation and recommends assuming an average annual rate of return of just 2.5%. According to this scenario, NIS 34,000 will have been accumulated by the age of 28.
It’s important to stress that very young children should be given full advantage of the compound interest at their disposal, and therefore it is strongly recommended to invest 100% in stocks – the savings vehicle with the highest risk which, over time, generates the highest return. Pension funds have stock-oriented plans, and these are the best places to invest the Hanukkah gelt pension contributions for children.
In that case it can be assumed that the return earned over the first 28 years will be much higher than the annual 2.5% to 3.7% applying to a general pension portfolio composed of stocks, bonds, term deposits, foreign currency, and other devices, and that the amount accumulated will also be much higher. But for the sake of being prudent we set this assumption aside.
From the age of 28 until their retirement the grown-up children will already be saving like everyone else – through a pension fund charging average management fees lower than the maximum allowed (fees at Mivtachim average 3% on monthly deposits and 0.3% on the cumulative balance). Part of the money will go towards insurance components – at the expense of savings – with overall monthly contribution amounting to 17.5% of salary. Full tax benefits will apply, and our model assumes a starting salary of NIS 7,000 a month with a 2% annual increase.
All this will entitle our son to a monthly pension of between NIS 7,400 and NIS 9,720 at the age of 67 or our daughter to a pension of NIS 6,160 to NIS 8,007 at 62, depending on the average return attained over the years which we assumed to be in the range of 3% and 3.74%.
In any case, the Hanukkah gelt we saved for our children at the outset will increase their pensions by 12% to 16%, so the boy will receive NIS 9,720 a month instead of the NIS 8,362 he’d be entitled to had he only begun saving for his pension at 28 – a difference of NIS 1,357 a month. Meanwhile the girl will retire on NIS 8,007 a month – NIS 1,128 more than the NIS 6,879 she’d need to manage on if we hadn’t saved for her during her childhood.
The boost in pension applies from retirement age until death, so in terms of today’s life expectancies this would extend to a period of about 20 years.
The pension expert who assumed more conservative parameters, including monthly childhood contributions of just NIS 100, also concluded that the Hanukkah gelt savings would increase our children’s pensions by 12% to 13.4%.
So our kids might not be happy to forgo their Hanukkah gifts, but if we provide them an increase of over NIS 1,000 in their monthly pensions 60 years from now in exchange for saving just NIS 140 a month for now, we’ll probably make them much happier over their lifetime.
Have a happy Festival of Lights.