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A pension might seem an unlikely gift for a child, but thousands of grandparents and other family members are paying into pensions for younger generations, giving the money potentially decades to grow.
According to analysis from Lubbock Fine Wealth Management, 35,000 children under the age of 18 received pension contributions in the year to April 2024 (the latest year for which data is available), with a total of £68.4m paid into their pension pots.
The figures highlight the growing interest in using pensions as part of wider estate planning, an issue that has become particularly relevant as the rules around Inheritance Tax (IHT) and pensions are changing.
With effect from 6 April 2027, most unused pension funds and certain pension death benefits will be brought into the value of a person’s estate for IHT purposes.
This means families who may have previously viewed pensions as being outside the IHT net may now be considering whether they want to pass on some of their wealth during their lifetime instead. Find out more about these changes in our guide Inheritance tax and pensions: what’s changing in 2027.
Here, we explain why some families may consider paying into a pension for a child or grandchild as part of their estate planning, as well as the potential benefits and drawbacks of taking this approach.
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If you’d benefit from expert advice on how inheritance tax changes could impact your pension, Rest Less members can book a free initial consultation with Fidelius, a Chartered Financial Planning firm. It’s a chance to chat with a qualified financial advisor about your finances and how you might be able to reduce any potential IHT liability. There’s no obligation, but if they feel you’d benefit from paid financial advice, they’ll go over how that works and the charges involved.
Fidelius is rated 4.7/5 from over 2,600 reviews on VouchedFor, the review site for financial advisers.
How do I know if I’ll leave an inheritance tax bill?
When you die, IHT is charged at a rate of 40% on the value of your assets above a certain threshold, currently £325,000. However, if you’re married, or have a civil partner, you can leave your entire estate to your spouse or partner free of inheritance tax.
There is also a ‘residence nil-rate band’’ which applies in addition to the existing nil rate band, but only where the person who has died is transferring a property that was once their home to their direct descendants (for example, their children or grandchildren). The residence nil-rate band is currently £175,000, having increased to this limit in April 2020.
This means that where unused nil-rate bands and residence nil-rate bands can be transferred from a deceased spouse or civil partner, a qualifying estate of the survivor can potentially pass on up to £1 million free of IHT, meaning most people won’t leave their loved ones with an IHT bill.
However, the main IHT threshold has been frozen since 2009, and both this and the nil-rate main residence band will remain at £325,000 and £175,000 respectively until April 2031. The combination of these frozen thresholds and changes to the treatment of pensions means some estates that would previously have fallen outside the IHT net could face a tax charge in future.
Helen Morrissey, head of retirement analysis at Hargreaves Lansdown, said: “It’s a change that will boost the receipts of a tax that has already surged in recent years. The good news is that most people won’t be affected but those who are will be making plans to shield their loved ones as much as possible.”
You can find out more about inheritance tax rules in our guide What is Inheritance Tax?
Why are the benefits of grandparents paying into children's pensions?
For grandparents with significant pension or other assets, contributing to a grandchild’s pension can be one way of passing money down the family while also giving the child a potentially very long investment horizon.
Nicholas Clark, Chartered Financial Planner at Lubbock Fine Wealth Management, said: “It’s becoming increasingly important for people to get out ahead of the taxman when it comes to planning how they will pass on money to their heirs. Giving their grandchildren’s pensions a kick start is often a great way to do that.”
One of the biggest attractions of paying into a pension for a grandchild is simply the amount of time the money could potentially remain invested.
“The power of compounding is massive when it comes to investing through a pension,” said Mr Clark. “An 18-year-old might not start drawing down their pension for nearly 50 years – on that sort of timeline that initial investment can grow into something significant.”
In other words, money paid into a pension when a child is young could potentially have several decades to benefit from investment growth and reinvested returns, although of course growth isn’t guaranteed, and the value of investments can fall as well as rise over time.
Another major benefit of contributing to a pension on behalf of a grandchild is that they don’t have to be a taxpayer to benefit from pension tax relief
Even if a child has no earnings of their own, contributions of up to £2,880 a year can normally receive basic-rate tax relief, taking the total amount paid into the pension to £3,600. This is because under what’s known as the ‘relief-at-source’ system, the pension provider claims the 20% tax relief from HMRC and adds it to the pension. So, for every £80 paid in, £20 is added in tax relief, giving the child a £100 contribution.
The contribution does not have to come from the child, so a parent, grandparent or another family member can pay into a pension on their behalf. You can find out more about tax relief in our article How does pension tax relief work?
Will paying into a grandchild's pension reduce your IHT bill?
Paying into a grandchild’s pension can potentially reduce your IHT bill, but it’s important not to assume that a pension contribution automatically takes the money outside your estate.
As a general rule, gifts made during your lifetime can still be liable for IHT if you die within seven years of making them. There are various exemptions, including the annual gifting allowance and gifts that qualify as normal expenditure out of income, but the rules can be complicated. You can find out more in our guide Which gifts are exempt from Inheritance Tax?
So, if you’re considering making substantial pension contributions for grandchildren specifically as part of an IHT plan, they should consider the wider gifting rules rather than simply assuming the contribution is immediately outside your state.
The downsides of paying into a pension for a grandchild
While putting money into a pension could give a child a valuable financial head start, there is an important trade-off.
Pension money is designed for retirement, rather than shorter-term expenses such as university costs, a first home or a car.
Under current rules, most people cannot normally access a personal pension before age 55, although the normal minimum pension age is due to rise to 57 from April 2028 for those without a protected pension age. Learn more in our article Will the pension access age rising to 57 affect you?
That means money paid into a pension for a young child could effectively be locked away for many decades. While it might give them a valuable headstart for retirement, they might wish they had funds available much earlier in life when their finances may be more stretched.
Think about the future
There can be good reasons for grandparents to help younger family members financially, but putting money into a pension won’t necessarily be the right option for every family.
If the money could be needed by the child before retirement, a Junior ISA or other savings or investment options that can be accessed earlier may be more appropriate. You can learn more about these in our guide Financial gifts for children: what are the options?
Grandparents should also consider their own financial position first. Money given away during your lifetime is no longer available to meet your own future needs, including potentially care costs or unexpected expenses.
Ms Morrissey, of Hargreaves Lansdown, said: “It’s really important not to give away too much too soon. You don’t know how long you might live and you don’t want to put yourself in a position where you find yourself struggling. Speaking to a financial adviser can be useful in helping you to navigate inheritance tax so you can strike the balance of helping others while living well yourself.”
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If you’re considering seeking professional financial advice on the options available to you, we’ve partnered with nationwide Chartered independent advice firm Fidelius to offer Rest Less members a free initial consultation with a qualified financial adviser. There’s no obligation, however if the adviser feels you’d benefit from paid financial advice, they’ll talk you through how that works and the charges involved.
Fidelius are rated 4.7 out of 5 from over 2,600 reviews on VouchedFor, the review site for financial advisers.
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