The new child benefit system has come into effect, making it a means tested benefit from the 7th January 2013. Any household member that earns over £50,000 per annum will be affected by this new legislation, which is intended to reduce or remove the financial assistance of receiving Child Benefit for perceived high earners. This could apply to over 1 million families and a typical household with 2 children could see a reduction in income of up to £1,752 per annum from 2013/14 and those with 3 children could lose out by £2,449.
How it will affect you
- The child benefit payments will continue to be paid in full, however this will be clawed back by way of a tax charge on the household’s highest earner if their personal taxable income exceeds £50,000 per tax year.
- For taxpayers with income between £50,000 and £60,000, the amount of the charge will be a proportion of the Child Benefit received. For taxpayers with income above £60,000, the amount of the charge will equal the amount of Child Benefit received.
- The tax charge will be collected under self-assessment, so the first return will need to be in by 31 January 2014 for those submitting online. Please note that failure to do so could result in fines and late payment penalties.
- Not everyone will want to receive the benefit and have it clawed back through the tax system and therefore, it is possible to opt out of receiving the entire benefit.
Making a pension contribution can effectively wipe out the tax charge.
There is an opportunity to use pension planning to mitigate this tax bill, due to the detail of the new tax rules.
How it works
The tax charge comes into effect when the household’s highest earner’s ‘income’ reaches £50,000. However, this is based on ‘adjusted net income’ which is calculated as follows:-
- Total taxable income from all sources
less
- Pension contributions (gross amount).
What it means
By making a pension contribution, you can effectively reduce your net adjusted income and therefore eliminate the child benefit tax charge. This effectively increases the tax relief on your pension contribution.
Case Study
David and Catherine have 3 Children, David earns £60k a year and Catherine is a non-working mum.
David and Catherine have 3 children under the age of 16 and Catherine receives child benefit of £2,449.20 a year (£20.30 a week for the eldest child; £13.40 each for the younger ones).
As David has taxable income of £60,000 per annum, the tax charge completely cancels out the child benefit that Catherine receives. As they have not opted out of receiving the benefits Catherine still receives the child benefit, but David must account for it through self-assessment.
However, if David pays £10,000 (gross) into his pension, his adjusted net income becomes £50,000.
This means that David no longer suffers the child benefit tax charge plus he will receive 40% tax relief on the Pension contribution too.
So…. the net cost of adding £10,000 to his Pension is only £3,550.80. This is calculated as follows: £10,000 (gross pension contribution) – £4,000 (tax relief) – £2,449.20 child benefit tax charge saving) = £3,550.80. This is an effective rate of tax relief of over 64%.
Comment
A pension contribution may not be the most suitable solution for everyone and it does depend on individual circumstances etc. However, for those looking to build their retirement savings in a tax efficient way, the opportunity is clear.
If you are interested in a free initial consultation meeting to discuss this, or any other aspect of financial planning then please contact Phil Terry, an Independent Financial Adviser in our Investment Management Team on 0800 024 1976.