Inheritance Tax (IHT) liability has always been front of mind for those passing on wealth, but that anxiety seems to have increased tenfold recently – and for valid reasons. We’re facing down the barrel of another Autumn Budget, one year after the announcement that pensions would be brought into estates for IHT purposes, and many people are pre-emptively worrying that we’re due another big change in this area.
Whilst rumours abound as ever, there is of course no way to know what will happen until the day itself. We advise caution around making any big changes or moves ‘just in case’ something will happen – one lawyer in our network recently told us that a client of hers was talking about withdrawing their entire pension and taking the hit of the penalties therein, simply to avoid any potential rule changes around pensions and IHT! If you ask me, that’s not exactly acting with your best thinking cap on.
Of course, it’s understandable to want to plan ahead to mitigate IHT. Nobody wants to pay more tax than necessary, and for many families that we work with it isn’t just about preserving assets – it’s about passing them on efficiently and meaningfully.
Use regular gifts out of income to help boost your family’s pension pots
One of the most effective yet underused strategies combines gifting with pension funding. Moira O’Neill over at the FT actually contacted me last week for comment on this topic for an article of her own, which you can read here. But it’s truly a great strategy – by helping your children or grandchildren save for retirement, you can simultaneously reduce your Inheritance Tax (IHT) liability and make your wealth work harder across generations.
You can do this using your ability to make regular gifts out of surplus income, which is an often overlooked IHT exemption, to make additional contributions to your children’s or grandchildren’s pension. These gifts are immediately exempt from IHT, unlike lump-sum capital gifts, which are classed as Potentially Exempt Transfers (PETs) and must be survived by seven years to escape IHT, as explained in our guide to potentially exempt transfers and inheritance tax planning.
If you have more income than you need to maintain your standard of living, you can use this exemption to fund regular contributions to a child’s or grandchild’s pension. It’s a simple, compliant, and effective way to gradually reduce your estate’s taxable value while doing something genuinely beneficial for your family’s long-term financial wellbeing.
You can pay a maximum of £60,000 or your earned income (whichever is lower) into a pension fund each tax year. If you can use gifting to help your loved one top up their contributions and max fund their pension pot for even just a few years, this could have a massive impact on their overall fund value when they reach their 60s.
For example, a total contribution of £180,000 in the early 30s (costing roughly £100,000 after tax relief) growing at a modest 4% above inflation could be worth around £580,000 by their early 60s. That’s a powerful way to turn a family inheritance into a lasting financial legacy!
Why fund their pension pots instead of just giving it straight to them?
There’s no reason why you couldn’t gift directly to them and let them choose how to use it. However, paying directly into their pension enforces a long-term savings approach and will help them to start thinking in these terms too. They cannot access it until at least age 57 (this may rise over time), which gives you peace of mind that your gifts are ringfenced for your family’s future financial security.
It’s undeniable at this point that younger generations are having a comparatively rough time of it when it comes to savings, getting on the property ladder, and building wealth overall. Salary growth has stagnated, the income tax threshold has been frozen for years, rent is sky-high, and the general cost of living makes it difficult to save enough for a deposit to purchase a house without assistance from family. The reality is that, for many, it’s difficult to contribute more while they’re in their 20s and 30s – which would be the most opportune time to do so, to allow for as much compounding as possible.
Combined with the fact that many younger Gen Zers (or ‘Zoomers’) and younger Millennials actually also believe that the minimum pension contribution through auto-enrolment will be sufficient to fund their retirement (it won’t), it makes sense to lead by example and assist your loved ones in this way if you are looking to gift money to them to reduce your estate.
A great way to ‘recover’ some tax!
Pension contributions are remarkably tax efficient. When you pay into a pension on behalf of a child or grandchild, the government automatically adds 20% basic rate tax relief to the contribution. For example, a £2,880 net contribution is topped up to £3,600 in the pension.
For higher-rate or additional-rate taxpayers, the advantage is twofold. Many families are currently drawing taxable pension income to bring their Lifetime Allowance-related balances down ahead of potential post-2027 IHT exposure. Using some of this taxed income to fund younger family members’ pensions effectively “recycles” that tax by putting it back into a tax-advantaged environment. Which is pretty satisfying!
Isn’t this just reducing my taxable estate and adding to theirs?
Technically, yes. In real terms, not really. It might seem now as though you’re simply kicking the can down the road, but if you’re contributing to the pension of a 20- or 30-something, they’ve got at least 30 more years to go until they can even access it, let alone worry about their own estate’s IHT liability.
Plenty can and will change in that time in terms of policy and rules. The environment they’ll be faced with will almost certainly be drastically different and will bring new challenges that we simply cannot prepare for at this moment in time (I certainly couldn’t have predicted our current position in 1995!).
Provided they engage with their own planning – hopefully following the example set by you – they will be able to navigate that environment at the appropriate moment. There’s no point in trying to guess or allow for it now.
What next?
As we approach the Budget, the two key things to remember are:
- Significant changes to policy take time to become effective (for example, last year’s change doesn’t come into effect until April 2027). There is usually time to act after you have all the facts.
- Acting without a clear, long-term strategy can lose you more money overall. It’s important to balance your goals, principles, and the overall impact on your wealth and circumstances.
If you are still seriously worried about reducing your estate enough, helping your children or grandchildren save for retirement through regular pension contributions is one of the few strategies that can simultaneously reduce IHT exposure, reclaim tax, and create long-term family wealth. It’s simple, flexible, and, crucially, HMRC compliant.
Of course, these strategies should always be tailored to your personal circumstances and reviewed alongside your wider estate and tax planning. But as part of an overall family wealth strategy, pension gifting is a powerful way to ensure your money benefits the generations that follow and stays firmly in the family.
If you or your clients have any questions about strategic estate planning, please feel free to get in touch. Tax efficiency is one of our core areas of expertise, and our team excels at delivering tailored solutions.
