Child Benefit and the Child Benefit Tax Charge

In this article, I shall look at child benefits, the child benefit tax charge and ways to mitigate this hidden tax which has a big impact on parents with earnings over £50,000.

What is Child Benefit?

Child Benefit is a state benefit payable if you are responsible for raising a child under the age of 16, or 20 if they remain in approved education or training. It is paid every 4 weeks and there is no limit on the number of children that you can claim for.

You can choose not to receive Child Benefit payments, but you should still fill in the claim form because:

• it will help you get National Insurance credits which count towards your State Pension
• it will ensure your child is registered to get a National Insurance number when they’re 16 years old.

The fixed rate amount for Child Benefit is £20.70 per week for the eldest child and £13.70 per week for any additional children (2019/20 tax year figures).

Child Benefit Tax Charge

The Child Benefit tax charge was introduced in 2013 and impacts families with parents or guardians on higher salaries. If you or your partner earn over £50,000 then you may have to pay back some or all of your Child Benefit via the tax system.

For every £100 a parent/guardian earns over £50,000, they are subsequently required to pay 1% extra income tax. This means that the value of the child benefit is completely offset once one of the parents/guardians earns over £60,000.

The system is somewhat unfair in that both parents could be earning £49,999 each and suffer no tax charges (with a combined household income of £99,998), however if one parent is earning over £50,000 and the other is not earning at all, there will be tax to pay. This impacts single parents more severely.

Beware of benefits in kind

It is not only your salary that needs to be considered. You may also have additional benefits, the value of which could impact your adjusted net income and unexpectedly push you over the £50,000 threshold. If the benefits have been declared on your annual P11D, such as private healthcare, interest free loans (to pay for train season tickets for example) and company cars, then these are taken into account.

State Pension entitlement

Claiming Child Benefits will help you accrue National Insurance credits which will count towards your state pension entitlement. For this reason, it is a good idea to claim the child benefit in the name of the parent or guardian that earns the least in the household, or the one who is not earning at all.

It is possible to “opt out” of receiving the payments if you are earning over £50,000 but if you choose not to receive the payments, you will still receive your National Insurance credits.

How high earners can avoid a tax penalty on child benefit

After explaining what the benefits are and the potential tax implication for high earners, I will now move on to suggest a number of ways to avoid paying the Child Benefit Tax charge. All methods in effect reduce your adjusted net income, and if you can employ these methods and reduce this income back below £50,000, there will be no Child Benefit Tax Charge to pay.

Charitable Giving

By gifting to charity, you reduce your taxable income, as charitable donations are not taxable. Therefore, making a charitable donation that brings your taxable income below the £50,000 mark will in effect mean that you will continue to receive your Child Benefit without having to pay the Child Benefit Tax Charge.

Pension Contributions

Another way to reduce your adjusted net income is to increase your pension contributions. Any pension contributions made into a workplace or personal pension scheme will reduce your adjusted net income.

Depending on the type of pension your workplace offers, you could increase your salary sacrifice or net pay arrangements via your employers’ pension scheme or pay in additional voluntary contributions (AVC’s) into your occupational pension scheme.

Not only will you escape the Child Benefit tax charge, you will also receive tax relief on your pension contributions.

Case Study

Take Graham and Victoria, who receive £1,789 a year in child benefit for their two kids. Graham earns £60,000 a year while Victoria is a stay-at-home Mum. As things stand, Graham would have to pay back all the child benefit as a tax charge. Therefore, the effective rate of taxation between £50,000 and £60,000 is 57.89% (£10,000 taxed at 40% is £4,000, add on the £1,789 Child Benefit Tax Charge means that the tax is effectively £5,789 which is 57.89% of £10,000)

If Graham however makes a personal pension contribution of £8,000 (which qualifies for £2,000 in tax relief, bringing the gross contribution up to £10,000), this pension contribution brings Graham’s adjusted net income back down to £50,000 and no charge is payable.

By contributing £8,000, Graham has saved £1,789 and assuming all of the pension contribution lies in the higher rate tax band, he will also be able to claim an additional £2,000 in tax relief (20% of £10,000) via his tax return so the £10,000 extra Graham has got in his pension has actually cost him £4,211 (£8,000 - £1,789 - £2,000).

Childcare Vouchers

Although the childcare voucher scheme closed to new entrants in October 2018, if both parents and guardians are registered, restructuring the payments into this system can reduce your net adjusted income. It would be more tax efficient for the highest earner, who may be over the £50,000 threshold to take the maximum level of childcare vouchers to reduce their taxable income. If the higher earner is registered, and not claiming the maximum, then this is another area to consider.

Conclusion

The child benefit system does on the face of it seem somewhat unfair as it looks at the earnings of each parent/guardian as an individual, rather than at total household income. With some careful planning however, it is possible to escape the Child Benefit Tax Charge by deploying some or all of the methods mentioned in the article.

Should you wish to discuss anything in further detail, then do please get in touch on 07483050714 or [email protected]

Risk warning

As always with investments, your capital is at risk. The value of your investment can go down as well as up, and you may get back less than you invest. This information should not be regarded as financial advice.