News and Analysis | Author: Jonathan Cooper | 24 July 2024

Should you make pension contributions for others?

We briefly explore why paying contributions into someone else’s pension can be a really good idea. If you would like to find out more then do not hesitate to get in touch with your adviser, or any of the team here at Path Financial.

How does this work?

This is not a new idea and pension law fully supports such an approach. Known in pension parlance as a “third party pension contribution” we look at an example of how this can work in practice.

• Tina is semi-retired with an adult daughter and a young grandson.
• Tina has her own earnings and pension income. She has about £7,000 more income than she needs a year.
• Her daughter earns £65,000 a year and as such cannot claim the full child benefit allowance for her 3-year-old son.

Tina decides to pay £4,000 into her daughter’s pension and open a junior pension for her grandson, contributing £2,880 into it.

• For Tina’s daughter, the £4,000 pension contribution is increased to £5,000 in the pension through the addition of income tax relief from HMRC. This £5,000 contribution also reduces her relevant earnings for the Child Benefit calculation, and she can now claim the full amount.
• For Tina’s grandson, even though he has no earnings to support the pension contribution you are allowed to pay £2,880 into a pension each year which gets topped up to £3,600 by HMRC. Tina’s grandson now has a long-term investment account that will help support him when he comes to retirement.
• Both invest the money in a manner that makes a meaningful impact to people and planet.

As we can see from this one example it is a very significant strategy to assist with financial planning for the whole family.

Other merits

• Contributing to pension accounts for children, grandchildren or even great grandchildren is also good for inheritance tax planning. The maximum £2,880 contribution amount (where the recipient does not have their own earnings) is within the annual exempt allowance for gifts of £3,000. The £2,880 paid is therefore immediately outside of your estate.
• The £3,000 annual allowance is per person, so couples can make up to £6,000 of contributions to other’s pensions.
• One of the concerns some people have with gifting money to younger generations is that they have it in their pocket straight away and may not yet be mature enough to make the best decisions on how to use that money. By paying the gift into a pension wrapper, they cannot access it until minimum pension age, currently age 55.
• Paying into someone else’s pension and investing it in an impactful and meaningful manner not only has immediate benefits for people and planet but can also help educate and enlighten others around the benefits of such an investment approach.
• As the above example demonstrates it can help remove loved ones from tax traps, such as the Child Benefit trap and high-income trap.
• Couples can also use this strategy to improve the tax efficiency of their joint retirement provision. By evening out the value of pension savings each hold you can ensure you are using available income tax allowances for both parties in full when you reach your retirement years.
• Making third party contributions can help close the pension gender gap. On average women would have to work two decades longer to retire on the same pension amount as men.