Third-party contributions generate tax breaks and benefit high earners, as Bernadette Lewis explains.
Tightening annual and lifetime allowances may make funding spouses, civil partners and cohabitees’ pensions more attractive, and not just for the highest earners.
With third-party contributions, the member benefits from income tax relief on contributions made on their behalf of up to the greater of 100% of their relevant UK earnings or £3,600 (after allowing for any member contributions).
The individual paying the contribution cannot claim any tax relief and makes a gift on the member’s behalf. Inheritance tax (IHT) exemptions are often available.
If not, gifting cash to the member to pay their own contribution creates a potentially exempt transfer.
Otherwise, gifting a contribution directly to a pension outside the member’s IHT estate arguably is not a transfer of value, possibly creating a chargeable lifetime transfer.
Apart from the tax breaks, some couples might see this as redressing the financial balance for the partner – still usually a woman – with a smaller pension resulting from career breaks and part-time work while raising children.
Let’s consider two planning options, using simplified examples.
Recipient over 55
Tax relief and the freedom and choice reforms mean it is possible to make a money purchase pension contribution and immediately withdraw a higher amount.
One option is making third-party contributions for a partner with little or no taxable income, where the withdrawals are within their personal allowance.
This can still work even if the money purchase annual allowance, applicable once income is withdrawn, reduces from £10,000 to £4,000 (uncertain at the time of writing – see Fig. 1, below).
Recipient under 55
Third-party contributions are only tested against the member’s annual and lifetime allowances. This provides scope for those who have fully funded their own pensions to make further tax-efficient provision for their partners (see Fig. 2, below).
Bernadette Lewis is financial planning manager at Scottish Widows
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