If you’re an active investor, it’s likely that you are set up well for retirement. However, your children or grandchildren may not be prioritising retirement savings due to financial commitments such as debts or expensive mortgages, a young family or saving up to buy a home.
If this is the case with younger generations of your family and you want to help them, your initial inclination might be to pay into a pension for them. However, it might be better to help meet shorter-term financial pressures first, which might also free up capital, enabling your child or grandchild to make pension contributions themselves. “I always suggest paying debt off first, building up a cash reserve for emergencies and then thinking about long-term savings,” says Ian Cook, financial planner at Quilter.
Reducing and paying off debt is particularly important at the moment due to higher interest rates. A factor to consider when deciding whether to help pay off debt is its interest rate and how this compares to the levels of tax relief and employer contributions a payment into a pension might get, says Michael Lapham, director of financial planning at Mercer & Hole. It may be possible to pay someone else’s debts by giving the money directly to the organisation to which it is owed, although you would be likely to need your child or grandchild to give you the details of the debt and creditor.
Also, if the intended beneficiary has a young family and is sensible with money, helping with costs and/or debt might be better. Lapham adds that in such a situation, a priority is some kind of insurance or protection to cover the financial needs of the beneficiary’s family if they or their partner died or became unable to work.
Lifetime Isas
If your child or grandchild is a basic-rate taxpayer and hasn’t bought a first home, paying into a lifetime individual savings account (Lisa) might be a good way to help them build up a deposit. You can put up to £4,000 a year into these until the person in whose name it is held reaches age 50, and the government adds a bonus worth 25 per cent of the contribution’s value, so up to £1,000 a year. If not used to buy a first home, Lisas can be used to build up retirement savings, which are accessible tax free from age 60. Only 25 per cent of an individual’s pensions can be taken out tax free – any withdrawals above that are taxed at their marginal rate unless covered by their personal allowance for income tax, which is currently £12,570 a year.
If you withdraw money from Lisas before age 60, other than to buy a first home up to a value of £450,000 also using a mortgage or have a terminal illness, you have to pay a penalty worth 25 per cent of the withdrawal. So if your child or grandchild might need money for short-term needs, a regular individual savings account (Isa) from which you can draw tax- and penalty-free at any age might be better.
When to use a pension
A pension could be good if the beneficiary is not responsible with money, maybe because they are young, or you don’t trust them to use the money you give sensibly or as you wish. This is because from 2028 pensions cannot be accessed until age 57. “The long-term nature, tax relief, lack of access until reaching the minimum pension age and compounded gross returns make this a more prudent option than regular outright gifts to support a child’s lifestyle,” says Andrew Dixon, head of wealth planning at SG Kleinwort Hambros.
A pension contribution could also work well if the beneficiary already owns their home but their income is used up on other obligations, preventing them from making pension contributions – or at least not large ones.
You could pay money directly into a self-invested personal pension (Sipp) or personal pension for a child or grandchild. But if they have a workplace pension, contributions to this may also be matched by their employer up to a certain value, and charges for workplace schemes tend to be lower so eat into fewer of the returns. So if you opt for pension contributions, a workplace pension with employer matching should be the first port of call, says Lapham. However, you might have to give the money to your child or grandchild and trust them to put it into the workplace pension rather than being able to put it in directly yourself.
Pension contributions can get tax relief at the pension holder’s marginal rate, so are particularly attractive if the beneficiary is an additional or higher-rate taxpayer.
Another option is to put the gift into a discretionary trust, which would enable the parent or grandparent setting up the trust to control how much capital goes to the recipient and when. After seven years, the money put into the trust falls outside the parent or grandparent’s estate for inheritance tax (IHT) purposes.
