Avoid Losing Your Child Benefit
CHILD benefit is extremely valuable, worth £1,056 per year for the first child plus £697 for each subsequent child. A couple with two children receive £1,753 per year tax free; a couple with three children receive £2,449.
You receive child benefit until your children are 16 years of age, or until age 20 if they are enrolled in ‘relevant education’ (e.g. GCSEs, A Levels, or NVQs to level 3, but not degree courses).
That’s the good news. The bad news is the Government is withdrawing this benefit where any member of the household has annual income in excess of £50,000. The withdrawal will operate by levying an income tax charge on the highest earner in the household.
How the Child Benefit Charge Works
For every £100 by which the highest earner’s income exceeds £50,000, there will be a tax charge equivalent to 1% of the child benefit.
So, if the highest earner in the household has income of £51,000, the tax charge will be 10% of the child benefit. For a household with two children that means an additional tax charge of £175.30 (£1,753 x 10%).
Once the highest earner’s income reaches £60,000, all the child benefit will effectively have been withdrawn.
As an alternative to the income tax charge, the claimant can choose not to claim child benefit.
The 2012/13 Tax Year
For the forthcoming 2012/13 tax year, the charge will only apply to child benefit claimed during the period from 7th January to 5th April 2013 – i.e. one quarter of the tax year.
For example, if the highest earner’s income is over £60,000, the tax charge will be one quarter of the child benefit claimed. The remaining 75% will be exempt from the charge. So a household with two children will still enjoy child benefit of £1,315 (£1,753 x 75%).
If the highest earner in the household has income of, say, £55,000, the tax charge will be one quarter of 50% of the child benefit claimed. For a household with two children the tax charge will be £219 (£1,753 x 50% x 25%), leaving £1,534 of child benefit net of tax.
Squeezing ‘Til The Pips Squeak
Looking ahead to the 2013/14 tax year, the child benefit charge will create some truly eye-watering marginal tax rates for parents with income between £50,000 and £60,000.
In fact, anyone with three or more children falling into this income bracket will soon be facing the highest marginal rates in the tax system… rates so high that even Harold Wilson would have winced.
For example, let’s say the highest earner’s employment or self-employment income goes up from £50,000 to £51,000 in 2013/14. They will pay £420 more income tax and national insurance and incur an additional tax charge of 10% of the child benefit claimed – £105.60 for a household with one child.
So the total tax charge on the additional £1,000 is £525.60 – that’s a marginal tax rate of 52.56%! But, if you think that’s bad, take a look at the marginal tax rates suffered by parents with more than one child:
2 Children - 59.53%
3 Children - 66.49%
4 Children - 73.46%
Plus a further 6.97% for each additional qualifying child.
We haven’t even considered the possibility of tax credit withdrawals or student loan repayments. Taking these into account, there could be some people with marginal tax rates of well over 120%!
The marginal tax rates for the forthcoming 2012/13 tax year don’t look pretty either:
1 Child - 44.64%
2 Children - 46.38%
3 Children - 48.12%
4 Children - 49.87%
Plus a further 1.74% for each additional qualifying child.
Avoiding the Child Benefit Charge
Any parent with income between £50,000 and £60,000 (or slightly over), has an enormous incentive to escape these extortionate tax rates.
Some taxpayers (especially those earning just over £50,000) may be able to avoid the new charge altogether. Others (such as those with income close to, or over, £60,000) may need to think in terms of reducing the charge, or avoiding it only some of the time.
Not all Income is Equal
The child benefit charge only applies if your ‘adjusted net income’ is over £50,000. Adjusted net income includes all income subject to income tax, including income from employment, profits from self employment, pensions and income from property, savings and dividends.
Income from tax-free investments like ISAs is excluded. What this means is that a parent with work-related income of £50,000 and tax-free dividends of £10,000 from an ISA will avoid the child benefit charge completely; someone with the same £50,000 of earned income but £10,000 of rental income will effectively lose all of their child benefit.
This potentially makes investments like shares and bonds (that can be sheltered inside an ISA) far more tax efficient than rental property.
For example, that £10,000 in rental income will produce an income tax bill of £4,000 and a child benefit charge of £1,753 for a family with two children. Total rental income net of all taxes is just £4,247. The ISA investor ends up with 135% more income!
What Can Property Investors Do?
In the past, couples have often saved income tax by making sure investments like rental property are owned entirely by the spouse or partner who is a basic-rate taxpayer or earns no income at all.
Now it may pay to adopt this strategy even where both individuals are higher-rate taxpayers, for example if one has earnings of £50,000-£60,000 and the other has income of, say, £45,000.
Company owners may find it easiest to escape the child benefit charge because they can alter the amount of dividend income they receive each year and can spread their work-related income among family members (e.g. by gifting shares in the business to their spouse).
Company owners who want to avoid the charge must remember that it is not their cash dividends that must be kept below £50,000 but rather their gross dividends (found by dividing cash dividends by 0.9).
For the forthcoming 2012/13 tax year, this means you can take a tax free salary of £7,605 and a cash dividend of up to £38,156 without having to pay any child benefit charge.
Where both members of the household own the company, a total of up to £91,522 can be extracted without losing any child benefit.
Some company owners may want to extract more than £50,000 per year, especially if they cannot double up their income with a spouse/partner.
The solution here may be to pay a big dividend every second year.
Richard, a company owner with young children, normally takes a salary and gross dividend totalling £75,000 per year. If he continues to do this, the family will effectively lose all of its child benefit. As an alternative, he could pay himself an income of £100,000 in year 1 and an income of £50,000 in year 2.
His total income tax bill for the two years will be the same as before, but he will avoid the child benefit charge every second year (he should be careful not to pay himself more than £100,000, so he can keep his income tax personal allowance).
Similarly, a company owner who normally takes £60,000 every year could take £70,000 in year 1 and £50,000 in year 2.
Self-employed individuals may also be able to escape the charge to some extent by spreading their earnings (e.g. by employing a spouse or partner) or incurring more tax deductible expenditure (e.g. spending on equipment that qualifies for a 100% tax deduction under the annual investment allowance).
One of the simplest ways for almost all taxpayers (including regular salary earners) to reduce or eliminate the child benefit charge is by making pension contributions. Your adjusted net income is reduced by your gross pension contributions.
Alan has earnings of £55,000 in 2013/14. His wife earns £30,000 and claims child benefit for three children: £2,449. On his top £5,000 slice of income, he will pay £2,100 income tax and national insurance (42%) and a child benefit charge of £1,225 (50%), leaving him with just £1,675.
So he decides to invest £4,000 in a self-invested personal pension (SIPP). The taxman adds £1,000 of basic-rate tax relief, producing a gross pension contribution of £5,000. When he submits his tax return, he also receives higher-rate tax relief. This is given by extending his basic-rate band by his gross pension contribution, allowing £5,000 of income to be taxed at 20% instead of 40%. The total tax charge will be £1,000 and is covered by the £1,000 he did not invest in his SIPP.
Furthermore, because his adjusted net income is now £50,000, he escapes the £1,225 child benefit charge.
In summary, he ends up with £5,000 in his pension pot instead of £1,675 in after-tax income.
Where one spouse or partner is in the £50,000-£60,000 income bracket, it may be worth getting that person to make all the family’s pension contributions.
Chris and Maria are both higher-rate taxpayers earning £55,000 and £45,000 respectively and claim child benefit for two children. In the past, they’ve made gross pension contributions of £2,500 each and both enjoyed full higher-rate tax relief. In 2013/14, the couple decide that Maria should suspend her contributions and Chris should increase his by £2,500.
The couple will still enjoy the same amount of income tax relief but, by adopting this strategy, Chris will avoid an additional 25% child benefit charge (£2,500/£100), saving them £438.
Where both income earners in the household are in the £50,000-£60,000 bracket, the most tax efficient strategy is to equalise their adjusted net incomes.
Alistair earns £58,000, his wife Wilma earns £55,000. The couple want to make a £5,000 gross pension contribution to avoid some of the child benefit charge. If Alistair makes the contribution this will take his income to £53,000 and Wilma will become the household’s highest earner, resulting in a 50% child benefit charge.
The best solution is for Alistair to make a £4,000 contribution, with Wilma making a £1,000 contribution. Now they both have adjusted net income of £54,000 and an additional 10% of their child benefit is effectively retained.
2011/12 and 2012/13
THERE is no child benefit charge for the 2011/12 tax year (which ends on 5th April) and the charge is very low in the forthcoming 2012/13 tax year.
This means affected taxpayers should consider, where possible, paying themselves more taxable income in each of these tax years.
It may also be worth postponing pension contributions or tax deductible expenditure until 2013/14.