The Child Benefit Tax Trap

There’s been a lot of talk about ‘Stealth Taxes’ and in particular the freezing of personal allowances and the basic rate tax threshold beyond which people pay higher rate tax. However, did you also know that, if you (or your partner) earn more than £50,000, you will either have to pay back some of the Child Benefit you’ve claimed, or may not be entitled to any at all!?!

Some of you may have had salary increases recently that, due to inflation, haven’t really provided you with a ‘real increase’ in terms of your standard of living. With that in mind, this particular threshold, introduced in 2013, could be the one to catch you out! In my view, it is the 'stealthiest' of taxes for working parents, with it not getting as much ‘air-time’ and having never been increased since being introduced!

For every £100 of income earned between £50,000 and £60,000, there is a High Income Child Benefit Charge of 1%. In other words, someone who earns £52,000 would have to repay 20% of the Child Benefit earned, and someone who earns £60,000 (or above) would have to repay all of it!

With that in mind, if your income has increased above this threshold, it may not just be 40% tax on some of your income you now need to consider - the ‘cost’ of the increase could be much higher than this. For example, if someone with two children were to achieve a salary increase from £50,000 to £52,000 per annum, they would only actually see an additional £772 of that £2,000 pay-rise.

That’s a cost of over 61% on this chunk of income!

So what can you do about it?

Well one of the most tax-efficient things you can do is make a pension contribution.

Not only does this boost your retirement savings of course, but it also has the effect of extending your basic rate tax threshold as well as reducing your ‘net income for child benefit tax charge purposes’.

Let’s use the same example above – someone getting a pay-rise from £50,000 to £52,000 per annum and who has two children on which they are claiming…

If that person were to make a personal pension contribution of £1,600 (£2,000 gross), this would bring their income for these purposes down to £50,000 allowing for full claim of Child Benefit, and would also increase the point at which they start paying higher rate tax.

The upshot is that you would ‘regain’ around £415 which would otherwise have been lost to the High Income Child Benefit Tax Charge, you would be due a further £346 back from HMRC in respect of the earnings which should now attract basic rate tax instead of higher rate tax, AND you would get a £400 boost on the pension itself in the form of tax relief at source.

This means that, at a net cost to you of only £839 (i.e. £1,600 less £415 child benefit saving less £346 additional tax back from HMRC), you have been able to make a pension contribution of £2,000.

Pretty tax-efficient if you ask me!

Some important points to note…

• The charge applies if EITHER parent earns above the threshold. Therefore, it would apply where one person earns above £50,000 and the other earns nothing, but wouldn’t apply to a couple where both earn £49,000 each. Doesn’t seem fair I know – but those are the rules!
• The High Income Child Benefit Tax Charge is not automatic. You have to claim Child Benefit and then pay back any tax charge through a self-assessment. This process catches out thousands of parents every year – with some having reported being issued with ‘failure to notify’ warnings from HMRC!
• You can choose to opt out of getting Child Benefit payments, perhaps because your earnings are in excess of £60,000. However, it’s important to still fill in the claim form, even it is just to state you don’t want the payments. This is to ensure you get the National Insurance Credits you are entitled to AND your child gets a National Insurance number themselves without them needing to apply for one when the time comes.

If you find yourself in a position where your earnings could be affected by the Child Benefit Tax Charge and want to discuss your circumstances further, then please don’t hesitate to get in touch!