Adam Cole, Retirement Specialist at Quilter says third party contributions can clearly demonstrate the added value financial advice can provide, in particular to addressing the changing IHT landscape, as well as it being well publicised that the UK is not saving enough for retirement.
As most pensions benefits will fall within scope of inheritance tax from 06/04/2027, there has been a significant amount of focus on the importance of using these as part of a lifetime gifting IHT strategy.
My colleague Shaun Moore has set out how someone can ensure they effectively gift out of surplus income – see The growing importance of lifetime gifting – Professional Paraplanner
Following on from his article, I want to focus on some of the planning considerations and benefits gifting contributions into another person’s pension can achieve. These payments are known as third party contributions.
Income Tax Relief
Personal contributions into a pension are entitled to income tax relief whether they are paid by:
- the investor
- a third party
- a partnership account
- a sole trader account.
Income tax relief is given via three different methods:
- by deducting from gross income before tax is paid (net pay)
- by making a gross payment and claiming money back from HMRC directly (claims) or
- by having tax relief added to your pension (relief at source).
You are entitled to tax relief at your marginal rate on the higher of £3,600 or 100% of relevant UK earnings each tax year.
This is especially useful when factoring in children/grandchildren, allowing them to build retirement wealth even where they have no earnings. Importantly for third party contributions, the tax relief and annual allowance is assessed against the recipient not the donor.
For further details about pension contributions and tax relief see Pension contributions and tax relief | Quilter
Which pension scheme to use?
Not all pension schemes will accept third party contributions. Typically, personal pensions, stakeholder pensions and SIPPs will accept these and tax relief will be provided under relief at source.
Workplace pensions may allow such contributions, but availability will vary from scheme to scheme, so it is important to check.
For example, defined benefit schemes will not allow third party contributions to increase DB benefits, they may allow these into a money purchase AVC.
Using an existing pension arrangement
Having confirmed the scheme will accept such contributions, there are several advantages of using an existing scheme. A brief reminder of these includes:
- simpler/consolidated administration – fewer annual statements, less policies to keep a track of, consistency over the tax relief method claimed
- easier assessment against tax thresholds e.g. annual allowance, relevant UK earnings
- easier death benefit planning – e.g. fewer expressions of wishes to update, less policies for LPRs to have to deal with
- alignment with an existing investment strategy
- potential lower cost e.g. tiered charging structures.
Setting up a new pension arrangement
Where it is not possible to use an existing scheme, a new scheme can be set up. All advice firms will have their own basis for determining which provider they intend to use but these will no doubt feature highly in the criteria:
- online functionality
- excellent customer service and
- wide variety of investment options and product features.
The ability to set up pensions for minors (in effect a Junior PP or JSIPP) will also be a key feature for effective IHT planning using gifting out of income.
A couple of points to be aware of with any new pension arrangement:
- providers will likely require the person entitled to the benefits to be a UK resident when establishing the plan. Further details can be found under the definition of ‘Relevant UK Individual’ . This could be a potential stumbling block in some cases. For example, where a grandparent is seeking to pay £3,600 to multiple grandchildren, some of whom are not UK based
- it is possible for someone who was UK resident but is no longer, to claim tax relief for the five tax years after they left the UK. This presents a planning opportunity for those looking to leave the UK
- if someone has UK relevant earnings, then it is possible to set up UK pension scheme regardless of where they reside. Again, it’s important to check with the provider on their requirements.
Conclusion
Pensions are one of the most tax efficient wrappers available to savers. They offer both control and flexibility.
Control
Pension funds cannot normally be accessed until normal minimum pension age. This reduces the risk of money being spent prematurely.
Flexibility
They can be funded even where the recipient, is not working. For example, they are raising children, taking a career break or studying.
The changing IHT regime forces retirees with significant pension wealth to review their plans. Separately government analysis confirms the UK is not saving enough for retirement.
Addressing these two challenges through effective strategies such as third party contributions can clearly demonstrate the added value financial advice can provide.
Main image: pension, contribution, towfiqu-barbhuiya-jpqyfK7GB4w-unsplash
