The surprising benefits of paying into a loved ones’ pension

Finding ways to support your loved ones may be an important part of your financial plan, and there are many ways to potentially do this.

You will likely leave your estate to family members when you pass away and you may also consider gifting to support them while you are alive. But have you considered paying into a loved one’s pension?

According to a study reported by FTAdviser, 73% of people surveyed did not know they could pay into somebody else’s pension. Yet third-party pension contributions could be an effective way to support your family.

Read on to learn more about the surprising benefits of paying into a loved ones’ pension.

Contributing to a loved one’s pension could generate valuable returns

Whether you are starting a pension for a child or grandchild, or helping your partner boost their retirement savings, starting early is often beneficial.

The pension provider typically invests the contributions you or they pay into their pension. So, the longer savings are in a pension, the more time they have to potentially grow.

Figures from Nest show how much difference it could make if you help loved ones take advantage of this by paying into their pension earlier in life.

They calculated that if one person contributed £200 a month to their pension – including employer contributions and tax relief – between age 32 and 42, they would pay in a total of £24,000.

Assuming they saw 5% growth each year, their pension pot would be worth £77,000 at age 60.

However, if they made the same contributions, with the same level of growth, between the ages of 22 and 32, their pension pot would be worth £125,000 when they were 60.

Although they contributed the same amount, their savings were invested for longer, allowing their pension to grow more. That’s why starting a pension for a child or grandchild may be so beneficial.

However, it can also be useful for your spouse or partner. If they earn less than you or take a career break, by paying into their pension, you can ensure they don’t miss out on potentially valuable investment returns.

Paying into your partner’s pension could help you both build tax-efficient retirement savings

When you contribute to somebody else’s pension, the payments are treated as if the person who owns the pension made them.

This means that your payments contribute towards their Annual Allowance – £60,000 in the 2023/2024 tax year up to 100% of earnings, or £3,600 gross if they are not earning. Crucially, it also means that they benefit from tax relief at their marginal rate, just as they would if they paid into the pension themselves.

Consequently, a basic-rate taxpayer receives 20% tax relief at source when you make the contribution, and additional- or higher-rate taxpayers may be able to claim more tax relief through self-assessment.

Because the recipient benefits from the tax relief on top, a pension contribution could be more valuable than a cash gift. Paying into an adult child’s pension, for example, can be an effective way to pass on wealth, particularly if they are a higher- or additional-rate taxpayer and can claim extra tax relief.

Third-party pension contributions may allow you to use your Annual Allowances more efficiently

Planning together and contributing to your partner’s pension can help you make more efficient use of both of your Annual Allowances.

If you are close to reaching your Annual Allowance, you will pay tax charges on any contributions that exceed the limit. Yet, if you contribute to your partner’s pension instead of your own, they will still benefit from tax relief until they also reach their Annual Allowance.

Third-party pension contributions may be especially useful if one of you is affected by the Tapered Annual Allowance. This reduces the amount that you can pay into your pension and receive tax relief on. In the 2023/24 tax year, this may affect you if:

• Your threshold income – all income minus your own and employer pension contributions – is more than £200,000.
• Your adjusted income – all income including your own and employer pension contributions – is more than £260,000.

If these criteria apply, your Annual Allowance reduces by £1 for every £2 of adjusted income above the £260,000 threshold, down to a minimum of £10,000.

In this instance, if your tax-efficient pension contributions are limited by the Annual Allowance you may want to consider paying into your partner’s pension instead of your own to benefit from the relief available.

Joint planning and making full use of both Annual Allowances in this way could allow you to maximise the tax-efficient retirement savings you build as a couple.

You could reduce the size of your estate for Inheritance Tax purposes

Paying into a loved one’s pension could reduce the Inheritance Tax (IHT) that your family pays on your estate when you die. This is because lifetime gifting rules apply to third-party pension contributions.

As such, assuming you have not used your annual IHT gifting exemption elsewhere, the first £3,000 that you pay into somebody else’s pension immediately falls outside of your estate. Any additional contributions could fall outside of your estate provided you survive for seven years after making these gifts.

In some cases, the “gifts from income” exemption may apply if the contribution:

• Is regular
• Comes from your income, not your savings or other sources
• Is affordable without having to make sacrifices to your lifestyle.

Consequently, third-party pension contributions can be a tax-efficient way to pass wealth on to loved ones while you are still alive, potentially reducing the IHT that your family pays when you die.

However, it may be useful to seek professional advice to ensure that you understand pension allowances and gifting rules, so you do not inadvertently trigger a tax charge.

Your children or grandchildren may benefit from cash gifts earlier in life

Paying into a child or grandchild’s pension can be very beneficial as, even for minors, tax relief boosts the value of the gift. Additionally, they begin generating compound returns from a young age, which could mean that their pension pot is significantly larger when they eventually retire.

That said, there are some limitations to consider when paying into a child’s pension. For example, they are unlikely to be earning an income, so in the 2023/2024 tax year, you can only receive tax relief on contributions up to £2,880.

Additionally, they typically won’t be able to access wealth in a pension until they are 55, rising to age 57 from 2028. As such, they won’t be able to use the money to pay for university education or buy a first home, for example. So, you may want to consider whether a cash gift earlier in life may be more useful.

For instance, according to the Guardian, 1 in 4 people under the age of 25 rely on their parents to help them get on the property ladder. Adult children may also face financial difficulty during the cost of living crisis.

By giving them a cash gift instead of contributing to their pension, you might be able to help them meet financial milestones such as buying their first home or getting married. Supporting them with increased expenses could also allow them to keep contributing to their pensions and savings despite the additional financial pressure they may feel.

Get in touch

If you want to explore the potential benefits of third-party pension contributions, get in touch today.

Email enquiries@blackswanfp.co.uk or contact your adviser on 020 3828 8100.

Please note

This blog is for general information only and does not constitute advice. The information is aimed at retail clients only.

A pension is a long-term investment not normally accessible until 55 (57 from April 2028). The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Past performance is not a reliable indicator of future results.

The tax implications of pension withdrawals will be based on your individual circumstances. Thresholds, percentage rates and tax legislation may change in subsequent Finance Acts.

The Financial Conduct Authority does not regulate estate planning, tax planning or will writing.