Pension funding post-retirement: when can it make sense?

Once you’ve packed up work and set off into retirement, paying into a pension may be the last thing on your to-do list, especially if you feel your current savings are more than adequate to see you through.

But in a handful of scenarios, either topping up your own pension or paying into someone else’s can be a shrewd move. You could trim an unwanted tax bill or support a loved one’s financial future.

Here are three situations for you to think about.

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1) You re-join the workforce

Life has a habit of throwing up the unexpected. You may have no plans to work again, but things can change over time. You might miss the daily routine or are offered work that’s too good to turn down.

The latter happened to a family friend during the pandemic. He had been happily retired for several years but was offered a short-term work contract that was not only lucrative but gave him some much-welcome purpose during the various lockdowns.

While he had some savings in a self-invested personal pension (SIPP), the bulk of his retirement income was from a defined benefit (DB) pension - which pays a guaranteed income for life that rises every year with inflation. This meant that he had no facility to adjust or pause this portion of his income to avoid the new earnings tripping him into a higher tax bracket.

However, a useful tactic to reduce a large income tax bill is to make pension payments. And this option is available to you even if you’re retired. Provided you’re under age 75, you get 20% income tax relief up front, which comes in the form of a 25% government top-up and you can claim back an extra 20% or 25% via your tax return if you pay 40% or 45% tax, respectively.

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As the friend had already made flexible withdrawals from his SIPP, he was restricted by the money purchase annual allowance (MPAA), which at the time limited pension savings to £4,000 a year (the MPAA isn’t triggered if you take your 25% tax-free cash but haven’t taken flexible withdrawals or use the remaining pot to buy an annuity).

But given the freelance income pushed him into the 40% tax bracket, he could still pay £4,000 (£3,200 contribution and £800 government top-up) into his SIPP at a net cost of £2,400. When he decides to draw the money, 25% can be taken tax-free, while with some careful planning he’ll pay 20% on the rest.

The good news is that the MPAA has since increased to £10,000, meaning those who have triggered the allowance have more scope to top up their retirement savings and receive tax relief.

But let’s assume you haven’t triggered the MPAA. What are your options then? Instead of being restricted to £10,000 a year, you can pay £60,000 or 100% of earnings into a pension, whichever is lower.

Due to something called “carry forward” relief, which allows you tap into unused allowances from the previous three tax years, you could contribute even more.

2) You have an IHT problem

From giving your money away and investing in AIM shares to using discretionary trusts, there are various ways to swerve inheritance tax; it was once dubbed “the voluntary tax” for good reason.

Another option is to pay money into a pension. That’s because pensions generally fall outside your estate for IHT purposes. That said, there can be other tax consequences which depend on when you die.

If it happens before age 75, the total value of your pension pot can pass to your beneficiaries completely free of tax, regardless of whether they choose to take a lump sum or inherit the pot and draw income. That’s how things stand now, anyway. The government is proposing to scrap the ability to make tax-free withdrawals from an inherited pension pot - although these proposals are yet to be confirmed.

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If you pass away after age 75, while your pension is still IHT-exempt, whoever inherits the pot will pay income tax on any withdrawals at their marginal rate. So, if they’re in either the 40% or 45% bracket, the tax benefits might be negligible. This is something you must factor in if you plan to use your pension pot for estate planning.

On the flip side, the inherited pot can continue to benefit from tax-free growth until the beneficiary decides to take withdrawals.

Unless you’re still working, the amount you can pay into a pension is restricted to £3,600 a year, and you must also be under age 75 to enjoy the up front tax benefits – so it won’t solve all your IHT woes. But it’s something worth thinking about.

3) To give younger generations a helping hand

Using your accrued wealth and income to support the retirement aspirations of younger generations can solve two problems in one fell swoop. Not only can it help get your children’s and grandchildren’s later-life savings in better shape, but you can also reduce your potential IHT bill in the process.

There’s plenty of scope to help out here. You can start a pension for someone on the day they are born and pay into one until they reach age 75.

Even if the person you wish to support has minimal-to-no income, which will be the case if they’re a minor, you can pay £2,880 into a pension for them every year and the government will boost this to £3,600.

If you have several grandchildren, while paying the maximum every year may not be affordable, even smaller contributions can make a difference. As this fantastic article by Faith Glasgow highlights, a single payment of 1,000, made up of £800 from you and £200 of tax relief, and invested at an average 7% a year would be worth around £66,000 in 60 years’ time.

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But you don’t only have to support the youngest generations; you can make pension payments for your adult children too. This can be prudent if you have surplus cash or income, and their retirement savings are a bit light.

Something you must not overlook is the inheritance tax implications. If your total gifts for the year are below £3,000 (or £6,000 as a couple) then IHT isn’t a worry. The same applies if you can prove the gifts have been funded from surplus income.

If neither of these are satisfied, you must survive seven years before the gift moves outside your estate – it’s important to bear this in mind.

Before making pension payments for your children or grandchildren, any decision should be weighed up against their wider financial needs. If you would like them to enjoy the money before retirement, such as to fund university or a first-home deposit, then more accessible investments - or outright gifts if they’re old enough - might be more suitable. 

There is, however, no reason you can’t do both, if you have the financial capacity to do so, of course. Having an open and frank conversation with those you wish to support is a good place to start.