Uncovering the Child Benefit Tax Trap
13 June 2018
Why the trials and tribulations of parenthood now include the High Income Child Benefit Charge, aka the Child Benefit Tax Trap, says Prudential senior technical manager Mark Devlin
Parenthood does come with plenty of emotional pros and cons. There are plenty of sleepless nights and worry. But these can be offset by ‘emotional rewards’, I’m grinning to myself at time of writing as my three-year-old told me two days ago that she loves me higher than she can reach.
There’s also the financial impact, long gone are the days when they could earn their keep as a chimney sweep! There’s varying assessments online as to the actual cost of raising a child, my favourite was in the original titles of the Simpsons when Maggie was scanned at the checkout. Her cost was displayed as $847.63, which was the price of raising a baby in America for one month back in 1989.
Before I side-track into all the trivia in my head, I’ll get back to the topic at hand.
What is child benefit?
Child benefit can help those responsible for one or more children under 16 (or 20 for those that stay in approved education or training). You get £20.70 a week for the eldest child, and £13.70 per child after that. There is no limit to the amount of children you can claim for, although there may be limits on your sanity depending on the number of children!
Only one person can claim this benefit, so sadly both parents can’t claim for the same children.
You don’t have to claim this but, even if you are eligible and choose not to claim, it’s best to fill in the claim form as you will still get NI credits for state pension and it ensures that the child will get a NI number at age 16.
So, basically, Child Benefit can help with the costs associated with parenthood (£1,076.40 for the eldest child a year and £712.40 a year for subsequent children).
High Income Child Benefit Charge (HICBC)
While child benefit is valuable if you meet the eligibility criteria (https://www.gov.uk/child-benefit/eligibility) Finance Act 2012 introduced a tax charge for those with high income –this was effective from 7 January 2013.
The definition of high income in this circumstance is a household where one person in the household has Adjusted Net Income (ANI) of over £50,000 (either yourself or your partner) and child benefit is being claimed. The definition of partner includes those married, in civil partnerships or couples living together as if married or civil partners.
There was much discussion at the time about the ‘fairness’ that this only applies where one partner has this level of ANI and the other partner has no ANI compared to a household where both partners have £49,999 of ANI and no HICBC would apply. But I’m not getting into that, I’m just stating the facts.
So, for those affected by HICBC the charge is 1% of the total benefit for every £100 of ANI over £50,000. So by definition this trap applies between £50,000 to £60,000 as the charge at £60,000 is 100% of the benefit.
The charge applies to the partner with the highest ANI regardless of who actually receives Child Benefit. The amount of the charge will be collected through self-assessment or PAYE.
The recent Tribunal case
To justify my play on words in the heading, it’s worth remembering that not only do HMRC apply the HICBC, but they also have penalties for late repayments of tax and charges that are due to them. This aspect has the potential to lead to more costly consequences if the payments become excessively late.
This was highlighted in the appeal by James Robertson against HMRC. The crux of the case was that HMRC had said they had issued ‘awareness’ letters to all taxpayers at the time that had earnings in excess of £50,000.
On 1 February 2017 HMRC then wrote to Mr Robertson effectively claiming 3 years’ worth of HICBC totalling £2,755. This had to be paid within 30 days to avoid late payment penalties.
After much toing and froing the penalties totalling £528 (a little over 19% of the HICBC) were ruled invalid, although the HICBC still applied.
What could have been done?
There are a plethora of circumstances that can create a liability to the HICBC. The most common is purely down to salary.
As a pension expert, the most obvious way to mitigate this is with a pension contribution. But we have covered this one to many times and the mechanics of this are covered in our article in the PruAdviser Knowledge Library. To simplify it a pension contribution will reduce your ANI and the tax relief you can obtain can be much higher than the marginal rate for those affected (41% for those affected by the Scottish Rate of Income Tax (SRIT)and 40% for non-SRIT taxpayers).
But what of the quirkier circumstances, can anything be done for those individuals?
For those that can control their income (such as limited company owners) they may be able to restructure their remuneration in a tax efficient manner, again pensions can be used for any excess income left in the company, the ins and outs of this are covered in this article. But perhaps their partner is also a shareholder in the company maybe increasing their income (subject to the wholly and exclusively rules), and/or dividends (as long as the same dividend per share is the same) could get them out of this trap.
Slightly related to the above, what about income in the form or dividends from investments? For income tax purposes these are taxed differently, they still count towards ANI this also includes the dividends within the zero rate of tax. So if the dividend yield is likely to push a client into this trap (or exacerbate the problem for those that are caught in that trap) is it time to look at that investment and either put a wrapper around it, or swap the wrapper. An obvious wrapper swap would be to hold any shares or unit trusts in an ISA.
An added bonus of this wrapper swap would be that with the recent reduction of the dividend zero rate to £2,000, there would be less tax to pay. I mused on the benefits of wrapper swappinglast September, the tax traps were gleaned upon, but there are some potential quirks when using a bond.
When income isn’t income
Bonds can be very handy in providing an ‘income’ (to satisfy those with technical pedantry, the ‘income’ that is often referred to with bonds, is actually a regular repayment of capital) that doesn’t count for ANI. You can have up to 5% cumulative return of capital from your bond each year tax deferred. You only start paying tax if this 5% cumulative allowance is breached, or you have 100% of the original capital returned to you. So if you are only taking 2% from a bond each year (and no part surrenders are made) there will be no tax to pay until year 51.
When you pay tax on more than the slice
The other peculiarity with bonds upon surrender or exceeding the 5% cumulative allowance is that of top slicing to mitigate. It’s an in-depth calculation that my learned colleagues in the tax and trusts wing of the team know in depth. I rely on studying for exams on this subject. But we have this articlethat goes into how this can be very valuable to a client.
But the quirk we have here is that whilst this will work out your tax based on your marginal rate. Your marginal rate can move depending on your ANI. When calculating your ANI top slicing does not come into the equation, therefore it’s the FULL gain that is used to work this out.
So a Basic Rate taxpayer with £20,000 of income who has a £40,000 gain for an onshore bond held over 8 years would have no further tax to pay based on top slicing (the slice is only £5,000). If they claim Child Benefit they would have to repay all of the benefit received in the year the gain was made, owing to the fact that the ANI becomes £60,000.
This rule on ANI also occurs for the personal allowance reduction, as it’s the full gain that is used. More on this is detailed in this article.
But again this is a factor in the planning, as you have the option of partial surrenders from a bond as detailed here, so if you plan over a couple of tax years (assuming that full access is not required immediately), then this can be mitigated.
On a related note it’s also important to factor this in if a trust assigns segments to a beneficiary who claims child benefit. After assignment the tax on surrender will be assessed against the recipient. So would it be better to surrender the segment before assignment and pay the trustee rates of tax before making a distribution to a beneficiary if the effective rate of tax factoring in the HICBC is higher?
The above could also apply if parents assign a segment to their children (and the recipient claims child benefit).
As stated earlier parenthood has trials and tribulations, whilst not much can be done to avoid the emotional aspects, there are a variety of solutions to the impact of the HICBC that can be explored with clients. The right blend of wrappers and pension contributions can produce results that are emotionally pleasing on the financial side.