Pension contributions and estate planning

A look at how pension contributions can be used as part of an estate planning exercise to reduce an individual’s estate while also building up the retirement benefits for other family members.

Key Points

Individuals can make pension contributions on behalf of other family members, known as third party contributions.

Making contributions on behalf of other family members can reduce an individual’s overall estate for IHT purposes.

The individual receives no tax relief but the family members will receive tax relief as if they had personally made those contributions.

Family members receive the relief and they may also benefit from other tax savings for example, reclaiming personal allowance, avoiding the High Income Child Benefit Tax Charge.


What are third party contributions and how are they treated for tax relief?

  • Third party contributions are contributions paid into a pension plan, which are not paid by the member or employer.
  • Third party contributions are treated as if the member of the plan had made the contributions.
  • Any tax relief is given to the plan member and not the third party making the pension contribution on the member’s behalf.
  • Alternatively, an individual can gift monies to a family member and they could pay the monies directly into their pension plan.


How does making pension contributions on behalf of other family members save tax?

THE INDIVIDUAL:

  • Determines how much they wish to reduce the value of their estate by for IHT purposes
  • Can make gifts by way of any available exemptions. Any gifts that are outside available exemptions will still be potentially exempt transfers (PETs)
  • Either makes the pension contribution on behalf of the family member or gifts the money to them to pay into their pension plan
  • Reduces the value of their estate for IHT purposes by the value of the pension contributions, although if the gifts are PETs, they will not reduce the value of the estate for seven years.

THE FAMILY MEMBER:

  • Must have relevant UK earnings to cover the size of the contributions made (or, if none, up to £3,600 for schemes using ‘relief at source’)
  • Must have sufficient annual allowance available (and carry forward if applicable)
  • Can get tax relief at their highest marginal rates
  • Can potentially build up their retirement provision (in a tax-free environment)
  • May be able to reclaim personal allowances back or reduce or eliminate the High Income Child Benefit Tax Charge

Example - Rajiv

CAN HE REDUCE HIS IHT LIABILITY AND GIFT MONIES TO HIS CHILDREN, WHILE REDUCING THEIR TAX BILL IN THE PROCESS?

 

  • Looking to reduce his overall estate for IHT purposes
  • Would like to help his children – Ajay and Meera
  • Gifts £60,000 out of his estate (reducing his estate for IHT purposes after seven years)
  • Has used exemptions elsewhere, so gifts are treated as Potentially Exempt Transfers (PET)
  • Makes a £28,000 pension contribution for his daughter Meera
  • Makes a £32,000 pension contribution for his son Ajay
  • Contributions treated as if being made as personal contributions by his children.
  • Meera has UK relevant earnings of £40,000
  • Ajay has UK relevant earnings of £90,000

RAJIV

Gifts £60,000 out of his estate.
Potentially saving £24,000 in inheritance tax, providing he survives making the gift by seven years.

 


MEERA

Benefits from £28,000 (of this gift) paid into her pension scheme.
This is grossed up to £35,000 within her pension scheme.

  


AJAY

Benefits from £32,000 (of this gift) paid into his pension scheme.
This is grossed up to £40,000 within the pension scheme. He can also reclaim £8,000 higher rate tax relief through his tax return.

 


SOLUTION

This adds up to a tax relief and income tax saving of £47,000 or 78.3% on the original £60,000.


Planning considerations

THIRD PARTY PENSION CONTRIBUTIONS CAN HELP CLIENTS:

  • Build retirement benefits for other family members
  • Enable family members to benefit from tax relief at their highest marginal rates
  • To help family members make use of any unused carry forward they may have

PENSION TAX PLANNING CAN HELP CLIENTS:

  • Reduce the value of their estates for IHT purposes
  • Make use of their annual exemptions
  • Enable other family members to make tax savings, for example reclaiming the personal allowance or avoiding the High Income Child Benefit Tax Charge

This briefing note is also available as a PDF

This document is based on Canada Life’s understanding of applicable UK tax legislation and current HM Revenue & Custom’s practice, as at February 2019 and could be subject to change in the future. It is provided for professional advisers only. Any recommendations are the adviser’s sole responsibility.

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