Third party pension contributions may be exempt from inheritance tax if they meet certain criteria (Image: Getty)
Saving for retirement may seem like a distant problem that you don’t need to worry about just yet, but the earlier you start putting pennies away the better off you’ll be.
Almost anyone can and there is no minimum age to have one, so even a newborn baby can have their own pension if a sets one up on their behalf.
This is known as a and those who set one up can add up to £7,200 to pension pots for their family – and avoid inheritance tax in the process.
Financial advisory firm Path Financial says the maximum amount you can contribute to your child or grandchild’s pension per year is £2,880, where the recipient doesn’t have their own earnings. As such, if both parents or grandparents made the maximum contribution for a child, they could add £7,200 to the recipient’s pension pot per year – because tops up the amount by 20% as well (£3,600 per parent).
Additionally, third party pension contributions may be exempt from inheritance tax if they meet certain criteria. The government states that you can give away a total of £3,000 worth of gifts each tax year without them being added to the value of your estate. This is known as your ‘annual exemption’.
You can also give gifts or money up to £3,000 to one person or split the £3,000 between several people, and any unused annual exemption can be carried forward into the next tax year – but only for one tax year.
It means that if you made the maximum £2,880 pension contribution, this wouldn’t be classed as part of your estate as it is below the £3,000 annual exemption threshold, thereby avoiding inheritance tax too.
Path Financial explains: “Contributing to pension accounts for children, grandchildren or even great grandchildren is also good for inheritance tax planning. The maximum £2,880 contribution amount – where the recipient does not have their own earnings – is within the annual exempt allowance for gifts of £3,000. The £2,880 paid is therefore immediately outside of your estate. The £3,000 annual allowance is per person, so couples can make up to £6,000 of contributions to other’s pensions.
“One of the concerns some people have with gifting money to younger generations is that they have it in their pocket straight away and may not yet be mature enough to make the best decisions on how to use that money. By paying the gift into a pension wrapper, they cannot access it until the minimum pension age, currently age 55.”
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Parents or guardians who pay into a pension on behalf of a child will look after it until the child turns 18, at which point control will pass to them but they won’t be able to access the money in their pension until they reach the minimum pension age.
Financial advice firm St. James’s Place, once a child’s pension is up and running anyone can contribute to it, including grandparents, godparents, friends or other family members.
The firm explains: “As a child will rarely have earnings, you can usually only pay up to £2,880 into a child’s pension for the 2024/25 tax year. When you factor in the 20% in tax relief from the government, this adds up to £3,600.
“Saving into a child’s pension is a rewarding way to spread your wealth among your children and grandchildren. And it’s a gift that keeps on giving, since it helps mitigate an Inheritance Tax (IHT) liability by reducing the size of your estate.
“Payments may be covered by the annual £3,000 tax-free gifting allowance, or the exemption for regular payments if made out of surplus income.”
While making pension contributions for family members is a great way to help them kickstart their retirement savings, it’s important to be aware of the seven year inheritance tax rule.
The rule states that no tax is due on any gifts you give if you live for seven years after giving them – unless the gift is part of a trust, but if you die within seven years of giving a gift then there could be inheritance tax to pay on it depending on the amount.
The government explains: “Any Inheritance Tax due on gifts is usually paid by the estate, unless you give away more than £325,000 in gifts in the seven years before your death. Once you’ve given away more than £325,000, anyone who gets a gift from you in those seven years will have to pay Inheritance Tax on their gift.”