If you are thinking of making some tax-efficient gifts to your family, you could consider the relatively little-known but extremely tax-efficient possibility of making pension contributions on their behalf. This can result in a huge tax saving of 90% of the value of the gift overall, partly in inheritance tax savings and partly in income tax relief.
How is it done? You would make a gift of a certain amount of capital to, for example, your adult child, to put into their pension. This is a ‘potentially exempt transfer’ by you for inheritance tax purposes. If you survive the gift by seven years then there will be no inheritance tax to pay on it.
As far as your child is concerned, pension contributions made via a gift from you would attract tax relief at your child’s marginal rate of income tax. If your child is a higher rate taxpayer then they would receive 20% tax relief automatically, which would go straight into their pension to augment the gift, and they would also be able to reclaim a further 20% through their income tax return.
A limiting factor is that the person receiving the gift must have sufficient earnings in that year to cover the size of the pension contribution you are making on their behalf, as well as any contributions they may have made themselves. For example, if you were to contribute £10,000 to their pension, they must have an income of at least £10,000 in the same tax year. Most people can only pay up to £40,000 into their pensions each year with the benefit of full income tax relief.
By way of example, if you were to give your child £32,000 as a pension contribution, it would reduce your prospective inheritance tax liability by 40%. If your child is a higher rate taxpayer, they would receive £16,000 in income tax relief, £8,000 of which would automatically go into their pension, and a further £8,000 of which could be claimed back via their tax return. This would mean a total pension contribution of £40,000 plus £8,000 in cash, and so the overall tax savings on the £32,000 gift would be £28,800 or 90%.
Income tax may of course be paid whenever the pension is drawn down, but this is nonetheless a very tax- efficient way of giving money to your family, in the right circumstances. The idea of providing for your family after you are long gone may appeal, as may the idea of making gifts which will be tied up safely within a pension wrapper until your child reaches retirement age.
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Call us on (01494) 708688 or complete a free online enquiry if you would like to discuss making your will or power of attorney and tax-efficient gifts to your children. Chiltern Wills is a friendly, professional Will writing business based in Beaconsfield and run by former London solicitor, Rebecca D’Arcy. Rebecca will be glad to have a free, no obligation discussion with you about how Chiltern Wills can help with what you need.