Most pension savers will build up their retirement fund using individual contributions and some will be fortunate enough to receive employer payments too. However there is an alternative way of building up a pension pot.
Third party pension contributions are those made by an individual on behalf of somebody else. They are an excellent way to give the next generation a pension saving head start and also provide inheritance tax benefits for those actually making the payments.
There are three principal ways of making pension contributions and it is important to be aware of the way in which they each benefit from tax relief.
With regards to personal contributions, a relevant UK individual is eligible to receive tax relief on the higher of either £3,600 or their relevant UK earnings for that tax year. For example, someone receiving a salary of £30,000 would receive tax relief on contributions up to this level.
For those earning higher amounts there is a further overarching limit on tax relievable contributions to be considered – the annual allowance. In the current tax year this is set at £50,000 and is due to fall to £40,000 from April 2014.
Most individual contributions will receive 20 per cent tax relief at source. Higher and additional rate payers must reclaim their excess relief via self-assessment at the end of the tax year.
HMRC places no limit on the amount that an employer can pay into a UK registered pension scheme on behalf of an employee. However any payments made by an employer will still count toward the individual’s annual allowance. The two parties should therefore liaise with each other as to ensure that this threshold is not breached.
Employer contributions are paid gross into a pension. This is particularly advantageous for higher and additional rate taxpayers who do not have to claim their extra relief via self-assessment.
Standard Life define a third party pension contribution as ‘one made on behalf of a scheme member by a party other than the member or their employer.’
Therefore, if a grandparent was to make a pension contribution into their grandchild’s policy, this would constitute a third party contribution.
For tax relief purposes such a contribution is treated in exactly the same way as if the recipient had made the contribution personally. The donee’s relevant UK earnings for the tax year, together with the prevailing annual allowance must therefore be considered.
In a recent article on third party contributions written by Jeremy Branton, Scottish Widows use the example of an 82-year-old New Zealand resident who wishes to pass wealth to his granddaughter in the UK.
The fact that Bob is over the age of 75 and resident overseas is not important, as only the recipient needs to meet the eligibility criteria.
Lucy has no relevant UK earnings and so her grandfather can make a maximum contribution of £2,880 which will be grossed up to £3,600 after tax relief.
Scottish Widows argue that a third party contribution being made on their behalf might encourage younger people to start thinking about pension saving from an earlier age.
The pension provider also point to the inheritance tax (IHT) planning opportunities for those who make these third party contributions. This column has previously discussed some of the principal IHT exemptions which could be utilised in this respect.
Primarily by making use of the ‘annual exemption’ it is possible to make lifetime transfers of up to £3,000 per tax year. Furthermore any unused exemption can be carried forward for a maximum of 12 months.
Those wishing to remove more value from their estate could also make use of the ‘normal expenditure exemption’. In short this permits the transfer of unlimited amounts provided that it is done each year, and does not impact negatively on your standard of living.
There is also the ‘small gift exemption’ that allows the transfer of £250 to any number of people in a tax year.
It is also worth remembering that unlimited amounts can be passed between spouses. Regardless of which method is chosen, the previously mentioned limits applying to pension tax relief should also be adhered to.
Third party pension contributions are an excellent way to encourage pensions saving amongst the younger generation. They can also be used to remove wealth from your estate for IT.
* Trevor Law is a director with Merito Financial Services, chartered financial planners, based in Solihull.
E-mail: tilaw@meritofs.com
