Case study: Making pension contributions on behalf of your spouse

When it comes to tax efficient investing there is nothing quite as satisfying as a pension. Tax relief on contributions, tax free growth, 25% tax free lump sum and no inheritance tax combine to make pension saving attractive to investors.

In fact, pension saving has become so attractive that further restrictions on how much could be saved have been introduced. A 20% cut in the Lifetime Allowance and the tapering of tax relief for anyone earning over £150,000 means that many people have been forced to restrict their contributions.

If you are in this situation it’s worth considering who else in your family could be making a pension contribution. Anyone can make a pension payment of £2,880 and receive a 25% top up from the government, even if they don’t have any employment income.

In the days when you had to buy an annuity or pay exorbitant fees for an income drawdown policy there wasn’t a much value in doing this. The introduction of pension freedom means that it’s far easier to take money out of a pension. Alternatively you can leave it to your children as a way of saving Inheritance Tax.

Case study

Fred has stopped making pension contributions because his pension fund is near the Lifetime Allowance. In the past he has paid the maximum amount into an ISA each year for himself and his wife Jane who has no earned income. This year he’s thinking about paying some money into a pension for Jane instead.

Assuming he makes the same payment for 10 years and the contributions grow at 3% a year, after 10 years the pension would be worth £42,508 whilst the ISA would be worth £34,006. The difference being the tax relief on the pension contributions.

25% of a pension fund is available as a tax free lump with the rest subject to Income Tax, whereas withdrawals from an ISA are completely free of tax. If Jane has no other income she would be able to draw 25% tax free lump and then use her Personal Allowance to draw the remaining fund over three years. If she chose to draw the fund as one lump sum the Income Tax would be in the region of £4,177.

If Jane decides not to access the fund she can leave to her children free of Inheritance Tax. Assuming Fred & Jane’s joint estate is above £650,000, the ISA would be taxed at 40%.

Pension ISA
Value after 10 years £42,508.06 £34,006.45
One off withdrawal £38,331.85 £34,006.45
Withdrawal over 3 years £42,508.06 £34,006.45
Left in estate £42,508.06 £20,403.87

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