January 2013 saw the introduction of a high income child benefit tax charge. This was designed to recoup Child Benefit that was paid to families where at least one parent in the household earns £50,000 or more. HM Revenue & Customs (HMRC) estimate that 600,000 people are affected by the change.
The tax charge is 1% of the Child Benefit payment for every £100 of income over £50,000. This means that those earning £55,000 will have to pay of 50% of the Child Benefit that they receive. Those earning £60,000 will pay a tax charge equivalent of 100% of their Child Benefit.
Many people who are earning between £50,000 and £60,000 now find themselves caught in a tax trap. Not only do they pay 40% Income Tax on their earnings, but they also effectively lose their entitlement to Child Benefit.
What are the options?
HMRC states that the high income child benefit tax charge applies to those with a ‘net adjusted income’ of more than £50,000. ‘Net adjusted income’ is your income after certain deductions.
Making pension contributions can be very attractive to those caught by the Child Benefit Tax Trap. It has the effect of reducing the ‘net adjusted income’ meaning that the Child Benefit is restored and higher rate income tax relief is received. The net effect is that someone with four children making a £100pm pension contribution can do so at a net cost to them of only £28.50pm.
Many people choose to give money to charity each year and the government’s Gift Aid scheme has proven a popular way to increase the value of donations. One often overlooked fact is that higher rate income tax payers can claim back further tax relief from HMRC. The charity receives basic rate relief on the donation, but the difference between the basic rate tax and the higher rate tax originally paid on the donation needs to be reclaimed by the donor through their Self Assessment tax return. A further benefit of charitable giving through Gift Aid is that it reduces the person’s ‘net relevant income’ and therefore effectively restores the Child Benefit. It is therefore vital to keep a record of all charitable gifts.
If your income is derived in part from interest, investment or rental income, you may wish to consider moving savings or assets between yourself and your partner. This reduces the income of the person caught in the tax trap and reduces the amount of high income child benefit tax charge that they have to pay. If the person receiving the assets is a basic rate taxpayer, you will also be reducing the overall tax that you pay as a family. It goes without saying that care should be taken when transferring any assets, as the legal ownership of them is transferred outright. Married couples can transfer assets without suffering Capital Gains Tax, but unmarried couples should take extra care to ensure that they do not suffer an unexpected Capital Gains Tax charge on transfer.
The deadline is fast approaching.
People earning more than £50,000 per year who received Child Benefit before 5th April must register for Self-Assessment before 5th October.
Written by David Vaughan, Chartered Financial Planner at Plan Money. www.plan-money.co.uk