Julia Jones is 47. She has lived in the apartment above her boutique clothing store for many years. Her daughter, Flo, recently moved back into the apartment after Julia ended her civil partnership with her ex-partner Sara.
There was a financial advantage to the move, as Flo is just starting out as a freelance illustrator and has a very unpredictable income. However, her main motivation was to be on hand to help Julia around the apartment and shop as needed, as Julia suffers from osteoarthritis which has been gradually worsening.
Over coffee with her sister-in-law Karolina, Julia mentions how proud she is of her daughter for pursuing her dream job, and how grateful she is to Flo for wanting to help her at the same time. Julia tells Karolina that she would like to thank Flo with a surprise contribution to her pension. She hadn’t been aware that it was possible to contribute to another person’s pension until her ex-Sara had helped Flo to start her first pension last year.
Julia is worried, though, that contributing a significant amount to Flo’s pension could be seen as some sort of inheritance tax avoidance exercise, particularly if she does it more than once as she’s considering. She wondered if Karolina knew anything about this from her time as a legal secretary and working for legal aid charities.
Karolina warns that this isn’t her area of expertise and advises Julia to speak to a colleague of hers for confirmation; however, she doesn’t believe it poses a specific issue. Her understanding is that Julia’s contribution to Flo’s pension would be treated as any other gift for inheritance tax purposes, and therefore shouldn’t be a problem as long as Julia survives for seven years.
Julia decides to go ahead with her plan. She pays £16,000 into Flo’s pension, giving a total contribution of £20,000 with tax relief. Unfortunately, Julia hasn’t fully understood or considered the tax rules for third party contributions.
Separately, Flo has been planning to use money she recently inherited from her late grandmother to fund larger pension contributions, based on how much tax relief she would be eligible to receive. Thanks to a couple of unexpectedly large commissions, Flo’s total income this year is £30,000. She has therefore already contributed £24,000, to give a total gross contribution of £30,000 with tax relief.
Thank you but…
When Julia surprises Flo with the news of her contribution, Flo is extremely grateful, but immediately realises the possible problem with the tax relief. Julia had assumed the contribution would be eligible for tax relief because it was within her earnings and she was the one paying the money, but Flo isn’t so sure. She calls her provider and speaks to Danny, confirming her suspicions that contributions need to be within her earnings for the year in order to be eligible for tax relief.
Danny reassures Flo that he can arrange to have the tax relief corrected with HM Revenue & Customs (HMRC). He adds that an easy way for Flo to remember the tax treatment is that contributions made by anyone other than an employer are treated as if Flo made them herself.
This gives Flo another concern. Does this mean her mother’s contribution will also count towards the annual allowance? Danny confirms that this is the case. Even without the tax relief on Julia’s contribution, Flo’s pension will have received £46,000 of contributions during the year. Flo is surprised to learn that her mother’s contribution will be tested against the annual allowance, even though it didn’t receive tax relief.
Danny confirms that unfortunately this is the case, because personal and third party contributions are tested if they would be eligible to receive tax relief, even if the individual’s earnings mean they can’t receive any.
Flo asks Danny how she can pay the annual allowance charge she will incur. Danny explains that there are two methods. Flo can either pay the charge herself, or use a process called ‘scheme pays’ to pay the charge from her pension. Danny goes on to say that some providers will only offer scheme pays if three conditions are met:
- The annual allowance charge to be paid is more than £2,000
- The client’s savings into that pension scheme during the tax year were more than £40,000
- The client meets HMRC’s notification deadlines for confirming their intention to use scheme pays.
However, Danny confirms that Flo’s provider offers scheme pays on a voluntary basis, which means that Flo doesn’t have to meet these conditions in order to use scheme pays.
Flo decided to use scheme pays to pay her annual allowance charge. Her provider has a form for her to complete with all the required information for them to arrange to deduct the charge from her pension and pay it to HMRC. Danny mentioned that Flo will receive a letter from them later in the year stating that she has exceeded her annual allowance and prompting her to consider whether she needs to take action. Danny explains that it’s a regulatory requirement for providers to send these letters, even though in this case Flo is already aware and has taken action. She won’t need to worry about the letter when it arrives.
Julia is very sorry for causing Flo these issues, although Flo remains very grateful to her mother for her generosity. Julia resolves to talk to Flo about these matters in the future rather than trying to surprise her daughter.
Jessica List is pension technical manager at Curtis Banks
This case study is part of Curtis Banks’s ‘Meet the Joneses’ series of intergenerational case studies.