Passing wealth on to children (or wider family and friends) while minimising the inheritance tax liability on death is often a key objective for our clients. However, given the significant sums that can be involved, some are concerned that a gift could impact on their children’s career efforts, or fail to be invested for the long term.

A solution could be gifting by way of pension contributions, as a tax-efficient means of reducing an inheritance tax liability, while ensuring beneficiaries do not have immediate access to the funds.

Case Study

Mark and Jane are retired and over the years have built up a sizeable investment portfolio; therefore, they are likely to have a significant inheritance tax liability in due course. They also have substantial pensions in payment, such that they have significant surplus income each year.

They have a daughter, Sarah, who is age 40 and earns c£80,000 gross per annum. Mark and Jane would like to gift Sarah £25,000 each year, but they are concerned that if they were to gift her the money directly, it may not be invested for the long term.

After discussing with their Saunderson House adviser, they decide instead to use their gifts to help Sarah contribute to her pension

Advantages for Mark and Jane

As the gift is out of surplus income, and to be made on a regular basis, it immediately reduces the value of their estate for inheritance tax purposes. If either a one-off gift, or not out of surplus income, they would otherwise have to survive seven years to achieve an inheritance tax saving.

As Sarah cannot access the monies in the pension wrapper until after age 55, they have peace of mind that it should not affect her career efforts and it will be invested for the long term.

Advantages for Sarah

Basic rate tax relief (20%) is automatically reclaimed by the pension provider on Sarah’s behalf, and credited to the pension fund.

Monies within a pension roll up virtually tax-free, which can result in a significant sum after numerous years of compounded growth. In addition, the pension is outside of Sarah’s estate for her inheritance tax purposes.

As her parents have helped Sarah build a fund for retirement, her earnings (and the additional 20% tax relief she reclaims via self-assessment) can be directed towards other priorities, such as buying property, repaying debt or funding school fees for her own children.

Other Considerations

The effect of combining various tax reliefs can mean that pension contributions can be very tax efficient. For example, in the above scenario, the combined effect of saving inheritance tax and receiving higher rate tax relief on the contribution mean that, when looking at the family as a whole, the tax relief equates to 90% [see overleaf for calculation].

In practice, there are many factors that need to be considered when determining if a pension contribution is appropriate, and how much to make. To find out more on how tax planning can be used to help you and your family, contact Saunderson House and we will be delighted to help.

Worked example based on above scenario

If Mark and Jane contribute £25,000 to Sarah’s pension, the pension provider will automatically claim 20% basic rate income tax relief from HMRC and credit it to the pension, resulting in a gross contribution of £31,250.

As a higher rate taxpayer, Sarah will be able to claim the remaining 20% income tax relief via her self-assessment, resulting in an additional £6,250 in her bank account.

Accordingly, the net overall cost after all tax relief of a £31,250 gross contribution is £18,750.

As the gift is out of surplus income, and to be made on a regular basis, Mark and Jane will have saved 40% inheritance tax on the £25,000 gift.

As detailed above, for the family as a whole, the total tax relief equates to £22,500, or 90% of the £25,000 gift.

About The Author

Premal Dattani
Prem has been awarded a BSc in Accounting and Finance from the University of Warwick, followed by an MSc ...
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