pension contribution

Have you considered making a pension contribution on behalf of a family member? New figures published by insurer Canada Life show that this type of pension contribution can reduce an inheritance tax bill as well as attracting tax relief.

In one scenario shared by Canada Life, a 90% tax saving was achieved.

When you make a pension contribution for another family member, it is treated as if it is their own contribution to the pension.

As a result, the pension contribution serves the dual purpose of reducing the size of your taxable estate for inheritance tax purposes and attracting income tax relief.

For example, a pension contribution of £32,000 could save inheritance tax of £12,800 in the future.

There are some restrictions to consider before making this sort of gift into a pension on someone else’s behalf.

Any gifts are usually treated as a Potentially Exempt Transfer (PET), and the recipient will need sufficient relevant earnings to cover the size of the pension contribution.

Pension contributions will also be subject to their annual allowance limit, which is usually £40,000 a year.

There are some available exemptions when making gifts.

For example, you can gift up to £3,000 each year without it being subject to inheritance tax, and any unused £3,000 annual exemption can be carried forward from the previous tax year too.

You can also make gifts from your surplus income; these gifts must be regular and affordable payments out of normal income, without relying on capital to maintain your standard of living.

The person making the gift needs to live for at least seven years following the gift, for it to fall outside of their taxable estate.

Andrew Tully, technical director at Canada Life, said:

“Making lifetime gifts to family members by way of pension contributions is a little-known area of flexibility within the pension system, but from a tax perspective, is hugely efficient. Not only will the benefactor potentially reduce their inheritance tax liability, but the beneficiary will see immediate benefit from tax-relief on the pension contribution at their highest marginal rate.

“There are other benefits to consider apart from the obvious investment in the pension, including the ability to reduce the tax on other income. Higher earners can potentially regain their personal allowance if their income falls below £100,000, and you can even reduce or eliminate the High Income Child Benefit Tax Charge. Both increase the tax efficiency of the gift.

“As ever, with areas of personal tax and pensions, it is always wise to seek professional financial advice to ensure you don’t fall foul of the rules.”

The tax benefit of making a pension contribution as a gift to a family member depends on the value of your estate and the tax status of the person receiving the gift.

For example, if a benefactor’s estate was likely to be liable for inheritance tax and the recipient is a higher-rate taxpayer, then a gift of £32,000 would reduce the potential inheritance tax liability by £12,800 (40% of £32,000) and generate £16,000 in pensions tax relief (£8,000 going into their pension and £8,000 in higher-rate relief through self-assessment).

This generates a total tax relief of 90% on the original gift.