Pension Clinic: family members will thank you for helping them to build up a pension pot on their behalf – particularly if they are higher-rate taxpayers, as Steve Webb explains.
I often hear from grandparents that they would like to do something to help their children and grandchildren with building up a pension, so this month’s pension clinic runs through some of the things you need to be aware of if you are planning to help out in this way.
In principle, there is no reason why you cannot pay into a pension for someone else. If you want to pay into a pension for a child who has no income, the maximum amount you can contribute in a year is £2,880. The pension provider then claims tax relief on the contribution from HM Revenue & Customs at the basic rate of income tax, and the child ends up with £3,600 in their pension.
The £3,600 limit is per recipient rather than per donor – so if two grandparents wanted to contribute, it would be their total contribution that mattered. Note also that although it is you who is making the contribution, it is the recipient who gets to benefit from the tax relief on pension contributions.
Contributions to adults
In effect, this means that if you pay into a pension for someone else, the contribution is treated as if that person had made it. This can be particularly useful for any recipient in the higher-rate tax bracket, who will be particularly grateful for your pension contribution. I mentioned earlier that your contribution attracts tax relief at the basic 20% rate that is paid directly by HMRC into their pension. But your (adult) child can then claim back another slice of tax relief if they are a higher-rate taxpayer. This does not go into their pension but directly to them in the form of a reduced tax bill.
Furthermore, particular groups of higher earners could get additional benefit from your contribution. The first is couples with children where one partner earns more than £50,000 a year. Such couples are subject to something called the ‘high-income child benefit charge’. In brief, for every £100 of annual income earned by the higher earner, a tax payment is due of 1% of the amount of child benefit that they receive. Those on £60,000 a year or more have a tax bill of 100% of the child benefit received.
The good news is that when income is assessed for this charge, the earner can deduct any pension contributions, including money you as a grandparent have contributed. So as well as helping them build their pension, you may also be reducing the tax charge they face on their child benefit.
The second group that might particularly appreciate your generosity includes those earning between £100,000 and £125,000 (based on 2019/20 tax allowances). Individually, this group face a reduction in their tax-free personal allowance for every pound they earn above £100,000, until their £12,500 allowance is completely exhausted at earnings of £125,000 a year or more.
Again, the good news is that when their income is measured for these purposes they can deduct money that goes into a pension. This means your contribution can also help give them back some of their personal allowance for income tax.
As is clear from the above, there are plenty of reasons why an adult child or grandchild might thank you for putting some money into a pension for them. In addition, there may be inheritance tax benefits if you give money away now, rather than as part of your estate in years to come.
Bear in mind, however, that if you want to make contributions into a pension for an adult who may themselves be paying into a pension, there is an overall limit on the amount that can be paid in each year while still getting tax relief. Any contributions that you make would be counted against those limits, so if they are already ‘maxing out’ on their pension contributions up to the tax relief limit, they may prefer you to help in other ways.
In fact, probably the main thing to think about before you do so is whether there might be other ways you could help them that they would appreciate even more. For example, your grandchildren will be grateful for your generosity with a pension contribution, but won’t be able to benefit from it until they are in their late 50s. For some younger people, maybe helping finance driving lessons or a deposit on a house would be something that would help them even more.
Steve Webb is director of policy at Royal London.