Saving for future generations: part two

27 June 2018

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Following on from last month's article on how your clients can save for future generations. Our case study brings third party contributions to life.

Last month we looked at how third party contributions can help your clients to kick start future generation's retirement savings. In this case study we look at how this works in practice and the benefits it can offer. 

Meet Martin

  • Martin, age 63, is a retired senior manager with an oil company. 
  • He is widowed with one daughter, Maria, who is 35.
  • Martin receives a yearly retirement income from his defined benefit scheme of £60,000 but he only needs £35,000 a year to meet his living costs.
  • Martin has assets in excess of £1.2 million. And is worried about the amount his daughter will pay in inheritance tax when he dies.

Maria has one son, Hamish who is 4. Martin wants to provide financially for his grandchild’s future but does not want him to have access to the money at a young age. He has already rejected the idea of putting a large amount of money into trust.

Providing for the future

Martin sets up a pension plan for Hamish, and contributes £2,880 each year. Once tax relief has been added, his contribution is increased to £3,600.

If Martin saves this amount every year until Hamish’s turns 18, there will be around £81,567 in Hamish's pension. This assumes investment growth of 5% excluding charges.

If no further contrubutions are made, when Hamish reaches age 60 he could have retirement savings of £633,089. Still assuming investments continue to grow at 5% excluding charges.

Martin could carry on making contributions after Hamish reaches 18 or he might think about saving into another vehicle, such as a lifetime ISA, to help with a house purchase.

Martin could use his annual exemption or the ‘normal expenditure from income’ exemption. The annual IHT saving would be 40% x £2,880 (pension contribution) = £1,152.

Is Martin missing a generation?

Saving for grandchildren is a great idea but Martin could also help his daughter Maria. She has an adjusted net income of £55,000. This means that she is caught in the child benefit tax trap. For the £5,000 of income she has over the £50,000 threshold, she currently only receives £2,462 (£5,000 gross income, minus £2,000 income tax, minus £538 child benefit tax charge, which comes to £2,462). Maria knows that making a pension contribution could take her out of the trap but she doesn’t have enough disposable income to do that.

However, if Martin makes a pension contribution to Maria’s plan of £4,000 per year, basic rate tax relief increases the contribution to £5,000. This is deducted from Maria’s adjusted net income and she is no longer in the trap.

This means that Maria will now receive £4,000 instead of £2,462 of the £5,000.

The benefit of pensions for the whole family

From a family point of view the total tax saving made using this approach is £4,138 (IHT saving of £1,600, child benefit tax charge saving of £538 and higher tax rate relief of £2,000) from a £4,000 cheque.

Pension contributions don’t need to stop when the member can no longer contribute for themselves. Clients who are still working but who have lifetime allowance or annual allowance issues may also want to consider the benefits of pensions for family members. This allows clients to pass money through the generations in a tax efficient way, without the need for trust planning.

 You can read part one of our look at third party contributions here.

About the author

Clare Moffat

Head of Business Development, Royal London

Clare qualified as a lawyer and Notary Public in September 2002 and is a member of the Law Society of Scotland. Post qualification Clare spent 5 years at Aegon Scottish Equitable in the legal department before moving to Pinsent Masons LLP in November 2007. While at Pinsent Masons, Clare acted for many different pension providers before moving to Prudential for over 6 years and ended up leading the pensions side of the external facing technical team which involved presenting, writing articles for the press and developing adviser facing content. Clare joined Royal London in April 2018 to head up the external facing team of pension and protection experts.

Last updated: 05 Sep 2018

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