Many better-off clients are understandably focused on how they can maximise contributions into their own pension, whilst grandparents are often interested in giving their school age grandchildren a start on their pensions journey. But one area that’s often neglected is the advantage of contributing into a pension for a working age adult, such as a son or daughter. This can provide a triple bonus to the recipient as well as potentially reducing the size of the donor’s estate for inheritance tax purposes.
What isn’t widely understood is that if someone pays money into your pension, this contribution is treated as if you made it. For the recipient, this brings three potential benefits:
- For contributions into personal pensions, HMRC will add basic rate tax relief through the ‘relief at source’ process. So a parent paying £800 into a son or daughter’s pension is effectively giving them £1,000 once tax relief is added.
- Recipients who are higher rate (or additional rate) taxpayers can claim further tax relief through the annual tax return process. Although this money doesn’t go into the pension, it will reduce the tax bill of the recipient – a very welcome additional gift.
- For recipients affected by the High Income Child Benefit Charge (HICBC), a higher level of pension contribution results in a lower level of income when assessed for the HICBC and a potentially reduced charge. For example, someone whose income for HICBC purposes is currently £60,000 results in a charge that will wipe out the value of their child benefit. If their parent puts £8,000 into a pension for them, this is grossed up to £10,000 with basic rate tax relief and reduces their income for HICBC purposes to £50,000. So the tax charge is completely wiped out. A similar argument would apply to recipients caught in the personal allowance taper for those earning between £100,000 and £125,000 per year.
From the point of view of the donor, combined with the pleasure of helping their child build a bigger pension, this transfer potentially reduces the size of their estate for inheritance tax purposes provided it satisfies one of the tests for exclusion from IHT. This includes a gift made more than seven years before the donor dies, a regular gift which doesn’t reduce the donor’s standard of living or anything within the annual £3,000 ‘gift allowance’.
There are other options for older clients with money to spare. If they’ve exhausted their own annual or lifetime limits on pension savings, they may have a spouse or partner who hasn’t, and this is someone else who might be happy to receive a contribution into their pension. Of course, the donor must be careful not to run down their own wealth and risk leaving themselves short of money in later life.
But there can be no doubt, the potential for supporting an adult child through a pension contribution is probably a neglected area of family financial planning and one which can benefit donor and recipient alike.
You can see more detailed case studies about third party contributions in the following two articles on our adviser website: Saving for future generations Pt I and Saving for future generations Pt II