Use inheritance tax gifting rules to give children a £1m pension or a house

Laura Suter
8 August 2018
  • Use your annual £3,000 gifting allowance to help the kids rather than the tax man

  • Contributing to a pension for 18 years can generate a £1m pot by the time they retire

  • Use the money for a Junior Isa and hand the kids £90,000 by age 18

  • Save £43,000 in inheritance tax

Laura Suter, personal finance analyst at investment platform AJ Bell, said:

“Parents or, potentially more realistically, Grandparents can save on their inheritance tax bill and pass substantial sums to their children or grandchildren by making use of lucrative annual gifting allowances.

“Figures released recently showed record levels of inheritance tax were paid last year, topping £5.2bn. As more and more people are caught in the net of inheritance tax, it’s more important than ever to make use of the allowances the Government hands you.

“Usually gifts from an estate are subject to the ‘seven year rule’, where inheritance tax is due if someone dies within seven years of giving a gift. The rate paid is on a sliding scale. However, everyone can give away up to £3,000 each year outside of this rule, where no inheritance tax is due.

“Using this allowance regularly and the powerful effect of compounding over a long period of time, parents or grandparents can create life changing opportunities for their children or grandchildren, as well as saving up to £43,200 in inheritance tax.”

The Junior SIPP route:

Children can have a pension opened in their name, and they get 20% tax relief. However, you only get tax relief on pension contributions of up to 100% of your earnings or on £3,600 – whichever is greater.

As most children will earn nothing, they can make use of the basic limit and up to £2,880 can be put into their pension in the current tax year. This will be increased to £3,600 after tax relief.

If you contributed £2,880 for the first 18 years of a child’s life, topped up with tax relief to £3,600 and growing at 5% a year after fees, you would have a £105,197 pot.

If you then left that pot to grow at the same rate without contributing anything more, you’d have £1million pension pot after 46 years or by the time the child is age 64.

Everyone has a £3,000 annual gifting allowance so a couple can achieve this for two children or more if you get the grandparents involved.

Laura Suter comments: “The benefit of using a pension is that the children can’t touch the money until later in life, meaning that the power of compound interest will turbo-charge the returns. Because you’re investing over a very long time period, it’s likely that you could opt for higher risk investments and so end up with higher returns than the 5% we have used.

“Given the growing savings gap in the UK, a £1m pension pot is an amazing thing to create for a child and gives them one less thing to worry about as they struggle with student debt and how to get on the housing ladder.

“One potential pitfall is that if the children also make their own retirement provisions they could end up breaching the Lifetime Allowance on their pension, which is currently £1.03m.  However, this is now index linked and so it going to be significantly higher in 64 years' time and, in any case, that is one of the nicer problems you could give someone.”

The Junior ISA route:

Another option is to forgo the pension tax relief and instead opt for a Junior ISA, which could help the mounting challenge young people face of getting on to the housing ladder.

Junior ISAs can be used for children up to the age of 18, and cannot be accessed by anyone other than the child when they reach adulthood.  They have a higher contribution limit of £4,260 a year, meaning you can give away the full £3,000.

If a parent or grandparent put £3,000 into a child’s Junior ISA, contributing the sum for the full 18 years, they would end up with a £87,664 tax free pot at the end of it, at 5% growth after fees.

Laura Suter comments: “With a Junior ISA, once the child reaches the age of 18 they can access that money and decide whether they want to splurge it all or continue to invest it. Even with no further contributions, they would have £100,000 in their pot by the age of 21, and a £144,383 pot by the age of 28.

“Considering the average house in the UK costs £225,621 they would have a substantial 64% deposit at this point. Even in London, where the average house price is higher at £485,830, they would have a 30% deposit at this point.

The IHT saving:

“If both parents or grandparents used their full gifting allowance each year for 18 years they would move £108,000 out of their estate for inheritance tax purposes – saving them a potential £43,200 in inheritance tax. This plan obviously relies on those gifting the money having the cash to spare each year, and also that their estate would be paying inheritance tax.”

Laura Suter
Head of Personal Finance

Laura Suter is head of personal finance at AJ Bell. She is a multi-award winning former financial journalist, having specialised in investments. Laura joined AJ Bell from the Daily Telegraph, where she was investment editor. She has previously worked for adviser publications Money Marketing and Money Management, and has worked for an investment publication in New York. She has a degree in Journalism Studies from University of Sheffield.

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