Mitigating the child benefit tax trap
1 October 2019
LEBC Group highlights how families could reduce the amount of tax they pay on child benefit by increasing their pension contributions, with case studies.
Parents who have a taxable income of more than £50,099 per year are currently required to pay 1% income tax on child benefit for each £100 of income above this level, with the value reduced to nil once taxable income of one of the parents reaches £60,000. This applies regardless of whether the high earner is the parent of the child, whether they are married, civil partners or just living together.
The complexity surrounding the rules, which were introduced at the start of 2013, has prompted many parents to waive their right to child benefit, costing the average two-child family as much as £1,788.80 per year. For those with more children, the loss is even greater with each additional child receiving £712.40 per year.
It can also have a greater impact on single parents as it only requires one person to have income of over £50,100 to trigger the tax charge, so a couple could have joint income of up to £100,198 and retain their child benefit, but a single parent would only have half the allowance.
However, LEBC has said many parents earning between £50,100 and £60,000 could reinstate their claim to all or some of their child benefit by increasing their retirement savings.
Kay Ingram, director of public policy, LEBC, said: “Trying to save for your future, while bringing up a family, may seem hard to achieve but there are circumstances where making pension savings can increase state support for the family.
Parents have until 5 October to notify HM Revenue & Customs if they were affected by the High-Income Child Benefit Charge in the 2018-19 tax year so they can receive an adjustment of tax code. Those who fail to do so will need to file a tax return and pay any extra tax by 31 January.
The following case studies by LEBC show how the tax on child benefit can be reduced, or even removed for those whose income falls within the taxable bracket by making either a pension contribution or charitable donations, both of which reduce the amount of taxable income.
The Working Couple
Anna and John, parents of Amy aged 8. Anna earns £25,000. John earns £52,000 salary but also fluctuating bonuses; this year he expects to earn £60,000 in total. They have no other taxable income.
Child benefit of £1,076.40 pa is paid to Anna tax-free and she earns less than £50,099 so is not taxed on it. As John earns more than this he has been paying tax of £215 pa on the child benefit through PAYE. This year his bigger bonus would mean his extra tax bill will be £1,076.40 and he will pay tax of £12,576.
They have a choice of ceasing to claim child benefit, or notifying HMRC of John’s pay each year, or completing a tax return and paying the extra tax through self assessment. As John’s earnings fluctuate he is unsure what to do.
If John pays his £8,000 bonus into a pension plan, his taxable income will be below the threshold as the £8,000 he pays is grossed up to £10,000 in the pension scheme. There will be no tax to pay on the child benefit nor the £10,000 grossed up pension payment and his income tax bill would be £9,500. The net cost to the family of John’s pension savings of £10,000 is £4,924.
The Single Mother
Heather the single mother of two children has waived child benefit to avoid paying tax on it; she has a salary of £60,000 so thought there was no point in claiming it to be taxed on it. But Heather is a member of her firm’s pension scheme and pays 5% of her salary into it. This means that her £3,000 of pension savings per year reduce her income to £57,000 for the purpose of the High-Income Child Benefit Charge. She can claim £1,788.80 per year and after paying tax of £1,109 will still be £679.80 per year better off. Heather can use form CH2 to claim again and report her earnings each October for the previous tax year to HMRC to have the tax deducted via her tax code. Should she increase her pension savings she would be eligible to claim more tax-free child benefit.
Making charitable gift aid donations also has the same effect of eliminating the tax on the child benefit and relieving the gift at the taxpayer’s highest income tax rate.
Warning on pension credits
LEBC also warned that a parent of children born after 2013, who is their full-time carer, could risk losing their state pension as a result of waiving payment of child benefit. Not claiming child benefit can lead to a loss of credits for their state pension.
Ingram explains: “With each year’s credit worth £250 per annum of State pension, that is a serious concern and impacts women disproportionately widening the gender pension gap.”
State pension credits can be restored by completing a CH2 form available from the Department for Work and Pensions.
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