Kay Ingram, public policy director at LEBC, says parents and grandparents can use surplus income to help younger generations retire earlier by boosting their retirement pot.
It follows the news that with Covid-19 restrictions taking their toll on long-term savings, many working-age adults are now contemplating delaying retirement. In contrast, older, retired generations have seen little shift in their income with the State Pension rising by 4% and 2.5% since March 2020 and many spending less as a result of successive lockdowns.
Ingram says that parents and grandparents with surplus income or savings may be able to help younger family members to save for retirement through lifetime gifts and pensions tax relief.
Currently, lifetime gifts made from surplus income are exempt from inheritance tax, regardless of the amount given or how long the donor lives from the date of the gift. To qualify for this exemption, the gift must be regular and must not impact the donor’s standard of living.
Ingram suggests that making a gift from surplus income and saving this into a younger family member’s pension, which will be boosted by tax relief at their highest marginal rate of income tax, can help families overcome the short-term impacts of lockdown on their longer-term retirement plans.
To demonstrate how this would work, Ingram uses a case study.
Emily would like to reduce the inheritance 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 of her two children by making regular monthly payments into their pension plans; this saves potential IHT on her estate of some £8,000 each year.
The £10,000 pension savings made by Emily for each child automatically increase to £12,500 invested in the pension. The provider collects 20% tax relief from HMRC, which is added to the pension pot.
If the children are 40% or 45% taxpayers, they can include the pension savings made by their mother in a tax return and will receive an additional 20% or 25% tax credit, 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 inheritance tax + £5,000 pension savings tax relief).
If the children’s income is subject to 40% tax, they could claim another £2,000 each – and £2,500 each if they were 45% taxpayers.
Higher rate taxpayers residing in Scotland receive an extra 1% tax relief as they pay tax at 21%, 41% and 46% respectively.
For those unable to utilise IHT-exempt gifts from surplus income, they may be able to use the annual gift allowance of £3,000 which is also exempt from IHT and can be carried forward for one year.
Ingram says: “Stopping or reducing pension savings, even for a short while, can seriously disrupt long-term retirement plans. Where family members less impacted by the financial impact of lockdown can help, making funds available for pension savings can amplify the value of the gift once tax relief on pension savings is considered. Making those gifts now, prior to any future changes in inheritance tax, may help the pension savings benefit from any recovery as the economy opens up.”