Is this the ultimate in selfless gifting to your child?

Gifting money to your child or grandchild has become a hot topic. Many regard it as better to bask in the joys of generosity today rather than hold on to money and risk the imposition of inheritance tax tomorrow.

But it can be emotive and problematic, exposing relationship tensions and issues of trust.

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The level of interest in the issue - it is constantly coming up in our conversations with customers - suggests people are increasingly willing to overcome these complications to avoid inheritance tax.

The big driver is a change that kicks in next April, when pensions will become potentially liable for inheritance tax. Greater revenues are being collected on estates - June was a record month - and they are likely to balloon from next year. The Office for Budget Responsibility expects an increase of 67% in the tax take between now and 2030, collected from around 65,000 estates - a doubling from the latest tally.

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One common way of reducing a future inheritance tax bill is to make gifts at least seven years before your death - a variable that, admittedly, is unknown and uncontrollable. After seven years, the money should usually fall outside of your estate. And you can also freely gift £3,000 a year aside from this.

But gifting invites many emotionally tinged decisions and dilemmas. Common considerations include:

• Will my son or daughter blow the money?
• Will it undermine their work ethic or worsen their relationship with money?
• Will your gifted money merely end up in the pocket of a poorly chosen partner?

However, I believe there’s a way to gift that mitigates these risks but also happens to be a super-charged tax-efficient route to building wealth: by allocating some money into the recipient’s pension.

After all, many parents don't actually want to make their children richer today. They want to make them more secure tomorrow. This is how it works.

Why pension gifting is safer

Reason 1: The lock in

Junior ISAs are a common way forward-thinking parents try to give their kids a head-start. These accounts enable parents and grandparents to put away £9,000 per year, per child and that money should be free from UK tax. Control of the money swings across to the child at age 16 and at 18 it converts to adult ISA status and can be withdrawn.

Do they tend to blow it? Our data - for the Fidelity Personal Investing platform - is positive in this regard. Of 6,000 customers whose Junior ISA converted into an adult ISA after 2021, only 9% cleared out the account. And 35% have actually added money.

If a first property deposit is a priority, Junior ISAs, are a great option to get your teenager on the right track, followed by savings into adult ISAs and also Lifetime ISAs, which qualify for a government top-up albeit with some restrictions.

However, you may not want to run the risk that your hard-earned money is diverted from this, or other sensible options. Gifting directly into a pension is effective in mitigating this risk. There is no access to this money for decades: the age of private pension access will rise from 55 to 57 on 6 April 2028 and will likely be higher by the time today’s teenagers and 20-somethings reach retirement.

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Reason 2: The soured marriage mitigation

A pension may also offer greater protection if a marriage later breaks down and assets are split. While pensions can be taken into account in divorce settlements, particularly after long marriages, the fact that they are long-term retirement assets means they can be treated differently from readily accessible savings or investments. The outcome depends on the circumstances and there is no guarantee they will be excluded but there is potential.

Why pension gifting is super-charged

Stock markets offer great growth potential over the very long-term. Longer timeframes increase the chances of better riding out the ups and downs, history suggests. Returns have also been higher than would have been achieved from staying in cash. It is a way to supercharge the gifts you make, as the growth compounds, earning returns on your returns year after year.

But you can give it a further supercharged boost through tax breaks - and it is especially powerful for children.

Pension tax relief is one of the biggest financial perks you'll ever receive. For most people, every £80 you put into your pension becomes £100 thanks to tax relief, and higher-rate taxpayers should be able to claim even more. You should check the rules but for a child, it is simple.

You can open a Junior Self-Invested Personal Pension (SIPP) and harness the boost of tax relief immediately.  It 's classed as ‘relief’ yet the benefitting child doesn’t even need to have earnings or income to qualify. It is a gift on your gift.

A Junior SIPP allows you to contribute up to £2,880 a year, and the government automatically adds 20% tax ‘relief’, turning it into £3,600. The money is locked away until the child's minimum pension age, but that gives decades for investment growth to compound. It is one of the few opportunities to secure an instant, government-backed return before a child has even earned their first pay packet.

We ran the numbers on two theoretical scenarios, comparing money into a Junior ISA and into a Junior SIPP.

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How £8,640 becomes £297,777

Let’s consider what happens if you invested this maximum amount in a SIPP versus a Junior ISA each year for three years - from 15 years old to adulthood.

A parent contributing £2,880 a year for three years would invest £8,640 into a Junior ISA. The same cash contribution into a Junior SIPP (£3,600) becomes £10,800 after HMRC tax relief. Assuming 7% annual growth to age 65, that difference alone could add almost £60,000 to the child's retirement fund.

This is because you’re earning those returns on a larger, HMRC-boosted sum and the difference continues to grow and compound over time. By the time your child reaches age 65, your £8,640 invested into a Junior SIPP could have grown into a retirement nest egg worth between £118,000 and almost £300,000, depending on returns.

Additional value created by tax relief over 50 years

^{Source: Fidelity International. For illustration purposes only, based on nominal annual returns of 5% and 7% from age 15 to age 65. Annual contributions of £2,880 to a Junior ISA and £3,600 to a Junior SIPP}

Investment charges would trim these returns and the growth is not guaranteed but it illustrates a point on the power of tax relief.

Of course the inheritance saving on this scenario is small at £3,456 - 40% of the amount gifted. But the gifting could continue through their 20s, with the child or grandchild channelling the money into their SIPP. Generally, you can put £60,000 into a pension each year or 100% of your earnings (whichever is lower).

There’s a certain elegance to all this. Not only are you avoiding one tax - on inheritance - but you are using tax efficiency to stretch that tax exemption further. It is a rare opportunity in an age when the tax squeeze only seems to tighten.

A final word on inheritance tax

Before making any decisions, consider the adapted idiom of not letting the tax tail wag the financial plan dog. Is it really affordable? Can you make the gift and keep your own plans intact?

You should also carefully consider whether you will even face a liability. For married couples who own property, the allowance is up to £1m if they pass on their main home to their children or grandchildren. A rate of 40% is applied beyond that level.   

The reality is that a small portion of estates are liable. The most recently published statistics were published this week - for 2023/24 - and showed around 30,400 estates had to pay some inheritance tax, a fall of over 1,000 on the previous year. Only 4.7% of estates pay any tax. And the numbers also show the average effective tax rate paid by estates was actually 13%, compared to the headline marginal rate of 40%. Of course, the tax net will widen after next April’s change in the rules.  

The decision is not an easy one, and the dynamic changes at different life stages. It is certainly worth  monitoring your child’s attitude and behaviour as they reach their 20s and 30s. It should sway the preference you state on whether gifts should channel to SIPP or ISA.

As with many difficult choices, perhaps the ‘bit of both’ option is a happy compromise - some to help near-term goals of buying a home, some for long-term financial security, and maybe just some for fun in the here and now. Few things are more rewarding than watching your generosity be enjoyed by others - and it perhaps especially important for a doting grandparent.

The pension choice, however, is the ultimate act of delayed gratification and forward thinking. You're giving them options, dignity and financial independence in later life for which they may thank you. That it is meaningful legacy I would be happy to leave.

• Read more of our articles on inheritance tax

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Important information - investors should note that the views expressed may no longer be current and may have already been acted upon. Tax treatment depends on individual circumstances and all tax rules may change in the future. Withdrawals from a pension product will not be possible until you reach age 55 (57 from 2028). This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to one of Fidelity’s advisers or an authorised financial adviser of your choice.