Saving enough money so that you can retire comfortably is an expensive business. Royal London say that you’d need retirement savings of around £600,000 to provide an income of £32,000 p.a. from age 65.
If you’re a senior exec or business owner, you’re probably already focused on how you can get the most from your pension. However, there are also many advantages for contributing into a grandchild or child’s pension.
Paying into a pension for a young child
If you have a child or grandchild under the age of 18, you can contribute up to £2,880 to that pension every year. With tax relief available at 20%, the government will top up your contribution to the maximum of £3,600 a year.
Additionally, because £2,880 is below the annual gift allowance, such contributions should not incur Inheritance Tax (IHT).
If you made the maximum contribution every year up to the age of 18, £51,840 will have been topped up by a further £12,960 in tax relief. And, with four decades of uninterrupted growth ahead, compound interest could see this become a considerable sum.
If an annual growth rate of 4% is assumed, after fees and inflation the Daily Telegraph report that, by age 18, the pot would already be worth £100,000: double the amount actually invested. With no further contributions, the child’s pension would reach £480,000 by age 58.
4 reasons to contribute to the pension of a working-age child
As well as the advantages of paying into a pension for a young child, there are also reasons to top up the contributions of your working-age child or grandchild.
1. Basic rate tax relief
When contributing to a personal pension, HMRC adds basic rate tax relief at source.
So, if you pay £800 into your son or daughter’s pension, you are effectively giving them £1,000 when the tax relief is added.
2. Reduce tax bill of a higher rate recipient
If your son or daughter is a higher rate (or additional rate) taxpayer, they can claim further tax relief on your contribution through the annual tax return process.
Although this money doesn’t go into the pension, it will reduce your son or daughter’s tax bill – a very welcome additional gift.
3. Child Benefit and Tapered Annual Allowance benefits
If your son or daughter is 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, if your child’s income for HICBC purposes is currently £60,000, they will face a charge that will wipe out the value of their child benefit.
If you put £8,000 into a pension for them, this is grossed up to £10,000 with basic rate tax relief. It also reduces their income for HICBC purposes to £50,000, removing the tax charge entirely.
A similar argument would apply to recipients caught in the personal allowance taper for those earning between £100,000 and £125,000 per year.
4. Reducing a potential Inheritance Tax bill
As well as helping your child to build a bigger pension, contributing to their retirement savings also potentially reduces the size of your estate for Inheritance Tax purposes. Your ‘gift’ will fall outside your estate if:
- You made it seven years before you die
- You made it from ‘income’ and it doesn’t reduce your standard of living (there are strict rules for this exemption which you should be aware of)
- It is within your annual £3,000 gift allowance
3 factors to consider if you’re thinking of paying into a child’s pension
While there are many good reasons to consider paying into your child’s pension, there are some factors that you should bear in mind.
- Think about the tax relief. If you are a higher rate taxpayer, paying into you or your spouse’s pension could give you 40% tax relief compared to the 20% you may get from paying into your child’s savings.
- Saving into a pension locks up the money until your child is at retirement age. They can’t use these funds in their earlier life when they may need it: for example, to pay for university fees or to buy their first home.
- Pensions have built-in political risk. Much can happen during the time your child’s pension is accumulating, and so changes to lifetime allowances or other factors could impact your child’s saving.
A case study
You want to make a pension contribution for your 4-year-old granddaughter, Olivia.
The plan would typically be set up by one of Olivia’s parents with the contributions coming from you. You can contribute up to £3,600 per annum, gross (£2,880 net) into the plan, but if Olivia had earnings (for example, she appeared in an advert), you could contribute 100% of her earnings.
Your contribution is classed as a gift for IHT purposes but, as £3,000 can be paid as an exempt gift, this more than covers the £2,880 net contribution payable if Olivia has no earnings.
If you can demonstrate that you can pay the regular pension contributions out of your income without affecting your standard of living, these ‘gifts’ would be exempt without the need to use your £3,000 exemption.
Of course, if none of these exemptions apply, but you survive for at least seven years after making the contribution, that contribution would be IHT free as it is a ‘Potentially Exempt Transfer’.
Get in touch
The potential for supporting a child or grandchild through a pension contribution is great and can benefit both you and the recipient.
If you want more information on how this may work for you and your family, please get in touch. Email firstname.lastname@example.org or call 01454 416 653.