The Child Benefit trap and how to avoid it.

The Child Benefit trap and how to avoid it.

 

If either you or your partner has an income of more than £50,000 a year before tax then you’ll have to pay back some (or all) of your Child Benefit in the form of extra Income Tax. 

 

An unintended consequence of this change is that some people are no longer claiming Child Benefit to avoid the tax, which means they are also missing out on an element of their accrual to the State Pension scheme. 

 

For those affected, there are options available to mitigate some or all of the tax. 

 

Each person’s income is taken in isolation as opposed to the combined household income, so if one partner has an income exceeding £50,000 each year, the higher earner of the two will have extra tax to pay – referred to as the High-Income Child Benefit Charge – but the child benefit amount will still be paid. 

 

If you or your partner’s income exceeds £60,000 the extra tax will cancel out the Child Benefit amount. 

 

Anyone with income below £50,000, which can include both partners, will receive the Child Benefit in full as no extra tax will become due. 

 

For every £100 of income above £50,000, 1% of the Child benefit amount needs to be paid as High Income Child Benefit Charge via a self assessment tax return. You can work out how much tax will become due by using the Government’s calculator: https://www.gov.uk/child-benefit-tax-calculator/main

 

It is possible to elect not to receive the Child Benefit thereby avoiding the payment of extra tax, however you are encouraged to complete the Child Benefit claim form in any event as this will mean you continue to accrue National Insurance (NI) credits. 

 

This is particularly important to those who have stopped working to look after children, as the amount of State Pension you’ll receive is dependant on your (NI) record. You now need a minimum of 10 qualifying years to receive anything from the state and 35 years to qualify for the full state pension. 

 

This is why it’s important to still claim the benefit even if there is no monetary value and you can still elect not to receive the actual payment. 

 

There is a way to avoid the extra tax, which means reducing your taxable income. This doesn’t mean getting a lower-paid job or even asking to reduce your hours and pay, but simply by making a pension contribution, opting to sacrifice salary for childcare vouchers (if your employer supports them) or by making charitable donations. 

 

Pension payments taken from income before you pay tax have the effect of reducing your taxable income, so if you reduce your income to less than £50,000 (after all allowances) there will be no High-Income Child Benefit Charge to pay. Additionally, pension contributions for those with this level of earnings will attract tax relief at 40% with 20% of the payment being reclaimed via self-assessment. 

 

Here’s an example 

 

Someone with an income of £55,000 could make a pension contribution of £4000 from their pre-tax income. This would be increased to £5,000 when 20% basic rate tax relief is added, meaning their income level would fall from £55,000 to £50,000 thereby avoiding the High Income Child Benefit Charge. 

 

Additionally, as a higher rate taxpayer, extra tax relief could be claimed via self-assessment, meaning the actual pension payment has only cost the individual £3,000 for the £5,000  that was contributed to the pension. 

 

At Gardner Financial Management our mission is to help our clients achieve financial independence and live their best life. 

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