I put £750 a month in a pension for my son - how does tax relief work? STEVE WEBB replies
I pay £750 into a Sipp for my son every month and the tax relief top-up is paid in automatically.
However, I am a higher rate tax payer. Can the additional tax relief be claimed or is it calculated at the basic rate which is my son's rate of tax?
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Generous: A This is Money reader puts £750 a month into a SIPP for her son
This is Money's retirement expert Steve Webb replies: People are often surprised to learn that it is possible to pay into someone else’s pension.
This applies to defined contribution type pensions, such as personal pensions, though not to more traditional defined benefit, or salary-related pensions.
In simple terms, if you pay into someone else’s pension, HM Revenue and Customs treat this contribution as if it was made by the recipient and not by you.
In your case, where the person with the pension is a basic rate taxpayer and the donor is a higher rate taxpayer, unfortunately there is no higher rate relief to be claimed.
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This is because your son is treated as having made the contributions himself and he is only a basic rate taxpayer.
As you say, because you are paying into a self-invested personal pension, or any other form of personal pension which delivers tax relief through the ‘relief at source’ method, basic rate tax relief is automatically added.
This means that on top of your £750 payment each month, HMRC will add £187.50 directly into your son’s pension.
He doesn’t need to take any further action to get this tax relief.
If, however, your son was in an occupational DC pension where tax relief is delivered through the ‘net pay’ arrangement, the recipient might need to contact HMRC to get the tax relief.
A second factor to be aware of is that because the money you pay into your son’s pension is treated as being paid by him rather than by you, this would not count against your annual limit for tax-privileged pension contributions.
This means that if, for example, you have exhausted your own pension annual allowance, you can go on making contributions into someone else’s pension without going over the annual allowance.
Another consequence of the contribution being treated as being made by your son rather than by you is that if he were a non-earner, he can only contribute £2,880 per year, topped up to £3,600 with tax relief, whilst benefiting from pension tax relief.
But as he is an earner, you can pay in an amount which, with tax relief added back in and including contributions by him, is no more than his annual wage.
One word of caution is that I notice you are paying £750 per month and that this ends up being worth more than £10,000 per year once tax relief has been added in.
You would therefore just need to be careful that your son has not previously taken pension money out and triggered the ‘money purchase annual allowance’ which limits his tax-privileged savings to £10,000 per year.
Check if you’ve gone above the money purchase annual allowance via the Government's website.
Should you pay into someone else's pension?
The decision as to whether it is a good idea or not to pay into someone else’s pension is a complex one, and the right answer will vary from person to person.
I give below some of the general pros and cons you may wish to consider, but I don’t go into more complex areas such as inheritance tax implications.
One advantage where the recipient is on a higher income is that money which is paid by them into their pension, or is treated as having been paid in by them, can be deducted from their income when things like the High Income Child Benefit charge is worked out.
We also know that there are high rates of ‘under-saving’ amongst the next generation, who typically will not have access to the high quality pensions of previous generations.
Anything you can do to help your son’s generation to build up a decent pension will stand him in good stead for the future.
For similar reasons, if one member of a couple has a much lower pension than the other, then paying into the pension of a spouse or partner can help to level things up.
This may be especially attractive if you are bumping up against your own annual limit for pension saving.
Another attraction of paying into a spouse’s pension is that in retirement each member of the couple has a slice of income which is free of tax, the personal allowance, and a slice of income only taxed at the basic rate, the basic rate band.
If one person in a couple has most of the pension income then they may well end up crossing into higher tax bands.
But if the pensions are more evenly split it is more likely that you will both only pay basic rate tax in retirement, saving tax overall.
The main thing to remember however is that saving into your own pension is currently very tax efficient for a higher-rate taxpayer such as yourself.
If you could benefit from higher rate relief if you save more in your own pension or if you could get generous contributions from your employer, then you need to make sure that it still makes sense to pay into someone else’s pension instead.
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