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Third party contributions

Introduction

This briefing sets out the points to consider when third parties pay contributions to pensions (including for children), the tax treatment and possible uses in financial planning.
 

Core considerations

  • Third party contributions can be made by someone other than a pension scheme member.   
  • Third party contributions are treated as if they had been made by the individual member and are subject to the same restrictions on tax relief based on the individual member’s circumstances. 
  • The individual member receives the benefit of tax relief on the third-party contribution – not the contributor.
  • Third party contributions are treated as a gift for Inheritance Tax (IHT) purposes.  
  • The use of third-party contributions can be a valuable part of financial plans for spouses/civil partners and for IHT planning. 

Contents


Uses of third-party contributions

Third party funding of pensions can be used in three key ways as part of a financial plan, including:

  • Maximising use of annual allowances between spouses/civil partners
  • Effective IHT planning – various exemptions allow immediate IHT benefits
  • Long term growth in a tax efficient wrapper

 

Third party contributions - tax treatment

Contributions can be paid by a third party on behalf of a pension scheme member, subject to the pension scheme rules or pension provider permitting this. The majority of third party contributions are made by individuals for their family, spouse, children or grandchildren.

The amount of the contribution which will receive tax relief is subject to the same rules as member individual contributions, so generally limited to £3,600 per annum or net relevant earnings if higher. In these circumstances contributions are treated as if they had been paid by the member which means that the member (rather than the contributor) receives any relevant tax relief, including eligibility to claim higher rate tax relief.  

If a new pension plan is being established it must be the individual member, and not the contributor, who makes the application for the plan. If that individual is a minor then a parent or legal guardian must make the application.
 

Treatment for Inheritance tax

The individual making the contribution is treated as having made a gift to the member for IHT purposes. This could be covered by an exemption: spousal/civil partnership exemption, normal expenditure out of income or annual gift allowance of £3,000, but if not, it will be treated as a potentially exempt transfer.
 

1. Contributions for spouses/civil partners

Where one person has significant earnings, and their spouse/civil partner has modest earnings with an underfunded pension provision, then third-party contributions can be a powerful planning tool:

  • Helps high earners overcome annual allowance restrictions.
  • Maximises pension savings across the household.
  • Gifts between spouses/civil partners are generally exempt from IHT, adding estate planning benefits.

 

Case Study – Ramesh & Priya
 

Ramesh earns £250,000 with a tapered annual allowance of £10,000. His wife Priya has income of £30,000 per annum and minimal pension provision, she contributes £1,500 per annum to her pension, which her employer matches.

After funding his own pension with £10,000 (using his tapered annual allowance) Ramesh can contribute £22,800 net (£28,500 gross) to Priya’s pension bringing her contributions up to £30,000 – her relevant earnings.   

This tax efficient wealth transfer balances retirement provision between partners and allows Ramesh to contribute more to the couple’s retirement saving than he could save into his own pension due to his tapered annual allowance.

 

2. Contributions for family members for IHT planning

Clients with surplus income and IHT concerns often seek ways to support family without triggering tax liabilities. Regular pension contributions for adult children or grandchildren can achieve this while enhancing their financial resilience. This is valuable to:

  • Pass intergenerational wealth in a tax-efficient wrapper.
  • Use the “normal expenditure out of income” exemption to gift excess income preserving annual gift allowances which can be used in addition.
  • Improve beneficiaries’ disposable income and free up their financial options.
     

Example – Samuel & His Grandsons:

Samuel (73): Large surplus income with IHT concerns, looking to reduce the value of his estate.

Grandsons: Daniel (basic rate taxpayer), Adam (higher rate taxpayer).

Samuel contributes £4,000 net annually to each grandson’s pension:

Scheme adds basic rate relief (total £5,000 gross per person).

Adam claims higher rate relief via self-assessment (a further £1,000), boosting his take-home pay.

The contributions from Samuel are made out of surplus income, they qualify for the normal expenditure out of income exemption from IHT, providing sufficient records are maintained so this exemption can be claimed following his death. This means that Samuel can still use his annual IHT gift allowance elsewhere.

  

3. Contributions for minors with an IHT saving

Grandparents often want to gift for the future without giving young children immediate access. Junior/Minor pensions offer a perfect solution: tax relief, long-term growth, and controlled access.

This is valuable to:

  • Lock funds until retirement age, ensuring long-term benefit.
  • Use small gift allowance and surplus income exemptions.
  • Creates a powerful compounding effect over decades.
  • Reduce IHT exposure
     

Case Study – Emilia & Her Twin Grandchildren

Emilia is 65, has Inheritance Tax (IHT) concerns and two years ago became a grandmother to twins Ariana and Nico.  She wants to put aside some money for the twins’ future but wants them to benefit in later life rather than having free access at a younger age.   

  • Initial contribution: £2,880 per child, grossed up to £3,600 with tax relief.
  • Ongoing contributions: £1,500 per child annually, grossed to £1,875.

Although the twins have no net relevant earnings they can still benefit from basic rate tax relief through relief at source but the gross contribution is limited to £3,600 each.

The initial contribution uses this year’s and most of last year’s small gift allowance.

Going forward Emilia will make contributions of £1,500 for each twin every year which means £1,875 will be invested for them.  This level of contribution is affordable to her now and in the future. 

The twins’ parents will need to apply for the personal pensions. The pensions will be held in trust for the twins until they reach the age of majority when they can make their own investment decisions, but not access the funds until minimum pension age.

 

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