Pension gifts can cut IHT bill by thousands

3rd February 2021 14:31

Laura Miller from interactive investor

Loading

Share on

These little-known tips can make your financial gift go further and increase the amount left to your loved ones.

Gifting your wealth into loved ones’ pensions before you die can save them thousands in inheritance tax (IHT) and make your financial present go further with tax relief.

Making pension contributions for others can be an effective way for the donor to reduce their taxable estate for the purposes of IHT. According to Prudential, a retirement company, people mistakenly believe they are limited to contributing up to £3,600 gross this way for children or grandchildren. 

But where the child or grandchild is in employment, and especially if they are a higher-rate taxpayer, the amount that can be contributed (and the extra benefit they can get from pension tax relief) increases considerably.

Canada Life, a pension firm, gives the example of Rajiv who wants to gift some of his wealth to his two children, Meera and Ajay.

Rajiv gifts £60,000 out of his estate, potentially saving £24,000 in inheritance tax (at 40%), providing he survives making the gift by seven years.

Meera benefits from £28,000 of this gift paid into her pension scheme. She is a basic rate taxpayer so this is grossed up to £35,000 within her pension scheme (by tax relief at the basic rate of 20%).

Ajay benefits from £32,000 of this gift paid into his pension scheme, which, because he is a higher-rate taxpayer, is grossed up to £40,000 within the pension scheme (by tax relief at 40%), and he can also reclaim £8,000 higher-rate tax relief through his tax return.

This, Canada Life pointed out, adds up to a tax relief and income tax saving of £47,000, or 78.3% on the original £60,000. 

However Kay Ingram of financial adviser LEBC cautioned individuals to do their sums before making big gifts. “Affordability of gifting is key. Not just in the immediate term but over the long term and cash flow planning can help establish this,” she said.

For example, a couple in their 60s with surplus income today may wish to be generous to their children and grandchildren. “But if they needed social care later or one died and pension income [was[ reduced, would they regret having given away their money?” Ingram pointed out. 

She added it is important for all involved in early inheritance gifting to have clear objectives for themselves, and to understand the financial needs of all the family. 

“Younger generations need to understand any limitations parents might have in terms of ongoing gifts, and whether a helping hand to one child may mean they will get a lower share of an estate than other siblings, who will also need to be kept informed if there is a lack of equality in the financial help given,” she advised.

These articles are provided for information purposes only.  Occasionally, an opinion about whether to buy or sell a specific investment may be provided by third parties.  The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.

Full performance can be found on the company or index summary page on the interactive investor website. Simply click on the company's or index name highlighted in the article.

Get more news and expert articles direct to your inbox

Sign up for a free research account to get the latest news and discussion, and create your own virtual portfolio.

Free Sign Up

We use cookies to ensure we give you the best experience on the website, making sure it functions well and making our communications to you relevant and useful. If you accept, you will accept all cookies on the II website. However, you can change your cookie settings at any time.