05 June 2019

Little known tax rule means parents can give triple boost to their children by paying into their pensions

7 min read

 
Steve Webb - Director of Policy

Steve Webb

Director of Policy, Royal London

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Mutual insurer Royal London has launched a campaign to make parents aware of the ‘hidden advantages’ of paying into the pension pot of their adult children.  For those parents who have spare cash, putting money into their children’s pension will boost the retirement prospects of their offspring (topped up by tax relief) and could also earn their children a tax refund (if they are higher rate taxpayers) and could reduce the hit they face if they are a higher earner receiving child benefit.

Under current rules, there is nothing to stop a parent making a contribution into the pension of an adult child. With millions of younger workers having been newly enrolled into a workplace pension, many now have a pension for the first time but are only making very modest contributions.   An additional contribution from their parent early in their working life, benefiting from compound interest as it grows, could help them to build a more meaningful retirement pot and is money that cannot be touched until later in life.

A little-known feature of the pensions system however is that the contribution by the parent is treated as if it had been made by the recipient.  So, for example, if a parent pays £800 into their child’s personal pension, the recipient will get basic rate tax relief on the contribution, taking the amount in the pot up to £1,000.    In addition, there are two further benefits to the recipient:

-          If the recipient is a higher-rate taxpayer, he or she can claim higher rate relief on the contribution made by the parent;  this would be done through the annual tax return process and would reduce the tax bill of the recipient;

-          If the recipient is affected by the ‘high income child benefit charge’ and is earning in the £50,000-£60,000 bracket (or slightly above), the money contributed by the parent is deducted from their income before the high income child benefit charge is worked out, thereby reducing their tax charge;  for example, if the recipient is earning £60,000 and therefore faces a child benefit tax charge of 100% of their child benefit amount, a  pension contribution by the parent of £8,000 (grossed up to £10,000 by tax relief) would reduce the recipient’s income to £50,000 for purposes of the child benefit charge and would completely eliminate the tax charge;

Apart from generally wanting to help their children, parents may be interested in this idea particularly because:

a)     They may be up against their own annual limits for pension contributions and may therefore have spare cash;

b)     Contributions may reduce future Inheritance Tax bills if they qualify for one of the standard exemptions such as regular gifts made from regular income;

The amount that the parent can contribute with the benefit of pension tax relief is not limited by the parent’s pension tax relief limit but by the limit that their children face – which in many cases will be up to their annual salary or £40,000, whichever is the lower.

Commenting, Steve Webb, Director of Policy at Royal London said:

“It is a little known fact that a parent who puts money into their child’s pension could be doing them a favour three times over.  First, the recipient will get a boost to their retirement pot, including tax relief at the basic rate.  Second, recipients who are higher rate taxpayers can claim higher rate tax relief on their parents’ contributions which will increase their disposable income.  And third, recipients affected by the high income child benefit charge can see this penalty reduced because of their parents’ generosity. 

”Not every parent has spare cash to pay in to their children’s pensions, but many will be in a better financial position than their children can expect to enjoy.  By paying in to their children’s pension they can give them a triple boost and improve their long-term financial security”.

Notes to editors

  1. The limit on the amount that can be paid into the recipient’s pension is determined by their ‘relevant earnings’. For example, if the recipient earns £25,000 per year and is contributing £2,500 per year into a pension (including employer contributions) then a further £22,500 can be contributed.
  1. The crediting of basic rate relief applies in cases where the pension scheme operates the ‘relief at source’ system of tax relief.  This applies to most group personal pensions and individual personal pensions.  If the recipient is in a MasterTrust which operates the ‘net pay arrangement’ tax relief cannot be claimed on the contribution.  However, if the recipient opens a separate personal pension, contributions by a parent *would* attract basic rate relief.
  1. Parents can contribute money into a child’s pension and this will reduce the size of their estate for Inheritance Tax purposes on death if a valid IHT exemption applies or after 7 years if there isn’t a valid exemption.  For example the “normal expenditure from income exemption” which is unlimited would apply if the contributions are not at such a level to reduce the current standard of living of the parents and are made on a regular basis, such as an annual contribution from the parents’ regular income.

For further information please contact:

Steve Webb, Director of Policy, Royal London

About Royal London

Royal London is the largest mutual life, pensions and investment company in the UK, with funds under management of £130 billion, 8.8 million policies in force and 4,046 employees. Figures quoted are as at June 2019.

At Royal London, we’re proud to champion the value of impartial advice. We believe it plays a crucial role in connecting people with the products that are right for them – and is key to delivering better outcomes and experiences for our customers. At the same time, it helps to build trust in our products and services.

Royal London works alongside advisers not in competition with them. That’s why we’ve made some key commitments to the intermediary market. You’ll find more detail on our commitment to advisers at http://adviser.royallondon.com/campaigns/our-commitments/