Saving for retirement income can be difficult when faced with the cost of bringing up a family. Yet putting pension funding off until the mortgage is paid, and the children have left home can mean retirement must be delayed. A 25-year-old paying £100 per month into their pension can expect a fund at age 65 of £64,000, but only £30,000 if they delay saving until age 45*
Parents and grandparents who may have good pensions and who no longer have debts, may be able to offer a solution to younger generations struggling to save for retirement.
Those who can afford to be generous can reduce their taxable estate for inheritance tax (IHT) by taking advantage of exemptions on lifetime gifts, enabling younger family members to scoop up pension tax relief they may otherwise forego.
Gifts from surplus income exemption
Lifetime gifts made from surplus income are exempt from IHT, regardless of the amount given or whether the donor lives beyond 7 years. To qualify for this exemption, they must be regular in nature (ideally paid over two tax years or more) and must not reduce the donor’s standard of living.
Emily aged 78 has a son Darren, 45 who belongs to his workplace pension scheme and daughter Sarah, 43 who is self-employed. Emily’s net worth is £1.5 million so her estate is likely to owe around £200,000 in inheritance tax, if current rates and allowances apply at the time of her death. Emily would like to reduce the tax on her estate and give some money to her children now. She has income of £50,000 a year after tax but only spends £30,000.
Emily is advised to gift £10,000 to each child by regular monthly payments which saves potential inheritance tax on her estate of £8,000 each year.
Pension tax relief boost
By making a third-party payment into a pension plan for each child, Emily can increase the value of her gift. Pension savings qualify for tax relief at the marginal rate of income tax paid by the pension plan owner. Most people have an annual allowance for pension savings of the lower of their earned income or profits, or £40,000, including any employer and third-party payments. Non earners may save up to £3,600 per year.
The £10,000 pension savings made for each child by Emily automatically increases to £12,500 invested in the pension. The provider collects 20% tax relief from HMRC added to the pension pot.
If Sarah or Darren’s income increases and they become a 40% or 45% taxpayer, they can include the pension savings made by their Mum in a tax return and will get an additional 20% or 25% tax relief,1 reducing their tax bill by this amount.
Each year £20,000 gifted by Emily gains the family £13,000 of potential tax savings (£8,000 IHT + £5,000 pension savings tax relief) rising to £17,000 if Sarah’s and Darren’s income would otherwise be subject to 40% tax.
Annual Gift Allowance
Each person may give one off gifts of up to £3,000 per tax year which are exempt from IHT. Any allowance unused from the previous year may be carried forward for one year once the current year allowance has been used.
Harold and Mary aged 80 are comfortably off but rely on care from their daughter Hannah, 55. Their joint assets are worth £1.3 million so they would expect £120,000 IHT bill on their estates , if inheritance tax rates and rules remain the same as now.
Hannah cares full time for her parents and her children so has no workplace pension. Her parents want to help her fund her retirement and are keen to pass money on to their grandchildren but don’t want them to have access to it just yet.
They can each give away £3, 000 annual allowance exempt from IHT. Hannah and her children have no earned income but are eligible to save into a pension with up to £2,880 per year. This will attract 20% tax relief, up to £720 per year, even though they are not taxpayers.
Harold and Mary pay £2,880 into Hannah’s pension which becomes £3,600 and £1,560 into a pension for each of the grandchildren which becomes £1,950.
£6,000 given reduces the IHT on their estates by £2,400 and the pension savings receive £1,500 of tax relief.
To explore how you could cascade funds to younger family members, reducing IHT and helping them save please contact your usual LEBC adviser, use our live chat facility, email firstname.lastname@example.org or call 0800 055 6585.
Public Policy Director
*Based on illustrations to age 65 with a monthly contribution of £125, £100 net of basic rate tax relief, medium risk growth assumption, provided by Aegon. These projections are not guaranteed.
1. Scots resident taxpayers may be eligible for an extra 1% of tax relief reflecting higher rates of taxation.
Please remember, no news or research item is a recommendation or advice to buy. LEBC is not responsible for accuracy and may not share the author’s views. The contents of this blog are for information purposes only and do not constitute individual advice. All information is based on our current understanding of taxation legislation and regulations. The Financial Conduct Authority does not regulate estate planning, tax advice, wills or trusts.
Tax rates, allowances and rules and the assumptions used above are based on current legislation. This may be subject to change.Back to News & Views