Funnelling money into a family member’s pension is one of the most efficient ways of reducing your estate for IHT purposes and comes with the added boost of income tax relief. Pension contributions made via a gift from another family member attract tax relief at the recipient's marginal rate of income tax. If they are not a tax payer, contributions will still benefit from relief at the basic, 20pc, rate. 

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For example, a gift of £32,000 would reduce the donor’s IHT liability by £12,800 (assuming their estate is above the IHT threshold). If the person receiving the money was a higher-rate, 40pc, taxpayer, they would receive £16,000 in tax relief, £8,000 of which would automatically go into the pension and £8,000 that could be claimed back through a tax return. This would result in a pension contribution of £40,000 and an additional £8,000 reclaimed via their tax return. 

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The total tax savings on the £32,000 gift would be £28,800, or 90pc. Of course, income tax might be paid whenever the pension is finally withdrawn. 

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Anyone who pays into a pension receives tax relief, meaning that their contributions are effectively topped up by the Government. Relief is granted at the saver’s “marginal” or highest rate, so people who earn more, receive more. From a tax perspective, it is hugely efficient. 

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However, there are a few restrictions for those considering making a gift in this way. Gifts are generally treated as “potentially exempt transfers”, which means that you can hand over an unlimited value without having to pay inheritance tax but you must live for another seven years after making the transfer. Failing that, at least part of the gift is added to the value of your estate and will be caught by IHT. 

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The person receiving the sum of money must also have enough earnings that year to cover the size of the contributions. So if the gift results in a £40,000 gross contribution to their pension, they must have an income of at least £40,000 in the same tax year. Individuals also have an annual allowance, which means they can only pay up to £40,000 into their pensions each year with tax relief. There are significantly lower limits for very high earners and those who have already made taxable withdrawals from a pension pot. 

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Finally, pension contributions are long term investments, the benefit from which is subject to pension age restrictions (currently minimum age 55). Consequently, this may not be appropriate financial planning where beneficiaries are likely to have a requirement for withdrawing capital before this age. 

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For many people with surplus income or capital and an estate subject to IHT on death, pension contributions made for beneficiaries is an extremely tax efficient means of killing several financial planning birds with one stone. If you would like to explore this further, please do not hesitate to get in touch.