Something as simple as using surplus pension income to contribute into a pension for their children can make a significant difference to the value of the inheritance they leave behind, according to the Old Mutual-owned company.
Funds held in capped drawdown can be very inefficient from a death benefit perspective, says Skandia. If the capital is to be paid to the children as a lump sum when they die, it will be subject to a 55% tax charge. This means the children will only receive 45% of the value of that fund when the parent dies. If a key aim of the parents is to protect their children's inheritance, and they are not utilising their maximum available income, it would make sense for them to use this surplus income for some proactive estate planning.
There are many ways in which parents are able to pass on surplus income to help their children, such as paying off their debts or reducing their mortgage. However, a tax efficient way of passing on wealth is by making a pension contribution for them. Any income tax suffered by the parent on the income they take is usually negated by the fact that contributions made on behalf of their child can be grossed up at the child's highest rate of tax.

Putting money into a pension means the parent is securing the long term financial future of their children, especially where a child's earnings may limit the amount they can currently save personally for their future. As the money is not immediately available, this removes the risk of their children 'frittering' away their inheritance. Instead they will have access to the money from the age of 55, when they could use the money to pay off their mortgage and help fund their lifestyle in retirement.
The following demonstrates how effective it can be from a tax and estate planning perspective to utilise surplus income from a parent's pension to fund a child's pension. In this example the parent currently has a drawdown fund of £300,000. If the parent takes no action, and they die 10 years from now, their drawdown fund could have grown to £495,000*. This would leave an inheritance of £222,750 for the child after 55% tax has been paid.
If the parent instead starts to take £10,000 a year from their drawdown fund to contribute into their child's pension, although the parent will suffer 20% income tax, the child will receive 20% tax relief (assuming both are basic rate tax payers)**.
So if the parent dies 10 years from now, their drawdown fund could now be worth £361,000. This would leave a lump sum of £162,450 for the child after 55% tax has been paid. In addition, the contributions paid to the child's personal pension could be worth £135,700 after 10 years, bringing the total value of the child's inheritance at that point in time to (£162,450 + £135,700 =) £298,150.
This simple planning could therefore increase the value of the child's inheritance by a staggering (£298,150 - £222,750 =) £75,400 after just 10 years.
Depending on the age of the child when the parent dies, they may not be able to access their pension immediately. If the pension stays locked away for longer, then it has more time to grow. For example, leaving the pension fund untouched for a further 10 years could see it grow to £231,406 and so on.
Adrian Walker, Skandia's pension expert, said: "Parents fortunate enough to have accumulated substantial savings may like to consider the best way to pass some of those savings on to their children. Parents are likely to be more successful with estate planning if they start sooner rather than later, and pass on some of their intended inheritance whilst they are still alive, especially if they know they have savings which far exceed their foreseeable needs.
"Utilising surplus pension income to fund a child's pension will help boost the value of the inheritance parents pass on to their children. A pension remains one of the most tax efficient forms of saving and it will ensure the child is better positioned to avoid any future retirement income problems. Those in retirement know better than anyone how important it is to have adequate savings, so what better way for parents to provide for their children than to ensure their long term security through opening a pension for them."

* Figures assume a growth rate of 6.5% p.a.

**To use such planning, the contributions made by the parent (plus any contributions currently being made by the child/employers) in any tax year must not exceed the greater of £3600 or 100% of the child's earnings.
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