2023 marks 10 years since the Child Benefit tax charge was introduced. Designed to reduce the amount of Child Benefit paid to higher earners, the measure affects millions of people earning more than £50,000.
Like many other tax thresholds, the amount you have to earn before the charge becomes due has not increased in line in recent years. It’s sat at £50,000 since its introduction in 2013, and so, as earnings rise, more and more families are being dragged into paying the charge.
Read on to find out what the Child Benefit charge is, why it could damage you or your partner’s retirement income even if you have opted out of receiving Child Benefit, and two strategies you could employ to mitigate the charge.
Earning more than £50,000 means you can lose some or all of your household Child Benefit
The Child Benefit charge is a tax charge that applies to anyone with an income over £50,000 who received Child Benefit, or whose partner receives it.
If you have to pay the charge, you will pay an amount equivalent to some or all of the Child Benefit that you or your partner is entitled to receive. The charge is equal to 1% of a family’s Child Benefit for every £100 of income that is over £50,000 each year.
If you earn more than £60,000, the tax charge will be equal to the total amount of Child Benefit you receive, effectively negating this benefit.
It’s worth remembering that it’s based on individual income. One of the quirks of the charge is that, if you and your spouse or partner each earned £49,999, then you would pay no charge. However, if one of you earned £60,000 and the other had no earnings, you’d lose all of your Child Benefit payments.
You should also remember that if someone without children moves into a household with children, they could also be caught by this tax charge.
Analysis by Royal London has found that, if the threshold at which the charge became payable had increased in line with the cost of living, it should be more than £63,000 today.
As it hasn’t, it now affects many more parents whose earnings have risen above the £50,000 threshold.
Avoiding the charge could have a knock-on effect on your State Pension
If your income is more than £50,000, the government gives you two options when it comes to this charge:
- Receive Child Benefit payments and pay any tax charge at the end of each tax year
- Opt out of getting payments and not pay the tax charge.
Many families simply elect to opt out of receiving Child Benefit to avoid the charge. However, this can have negative consequences for your State Pension – particularly if one of the parents doesn’t work.
That’s because a parent claiming Child Benefit for a child under the age of 12 benefits from a National Insurance (NI) “credit”. A year of NI credits counts as a “qualifying year” when it comes to establishing an individual’s entitlement to the State Pension.
Since 35 years of contributions are needed for a full State Pension, just one year of NI credits can be worth 1/35 of a pension.
The way to ensure that you or your partner don’t lose out is to still fill in the Child Benefit claim form, even if you don’t want to receive the payments.
This ensures the non-working parent continues to build up entitlement to their State Pension. It will also mean your child automatically receives a NI number without having to apply for one.
2 strategies for dealing with the Child Benefit tax charge
If you earn more than £50,000 and you or your partner claims Child Benefit, there are two main strategies you can employ to mitigate this tax charge.
- Make pension contributions
The income figure used to test against the £50,000 Child Benefit tax charge threshold is called “adjusted net income” (ANI) and is calculated as follows:
- Add up all taxable income from employment, company benefits, taxable profits from self-employment, interest, dividends, rental income, pension income, and taxable social security benefits
- Deduct pension contributions (gross value), trading losses, and the grossed-up amount of Gift Aid payments.
So, it follows that if you make pension contributions, your ANI would be reduced by the gross value of these contributions.
Here’s an example.
If your ANI was £60,000 and you made a net pension contribution of £8,000, this would gross up to a £10,000 contribution and reduce your ANI to £50,000.
In addition to eliminating the Child Benefit tax charge, you would also qualify for higher-rate Income Tax relief of 40% on the contribution.
- Give a charitable gift
Cash gifts to charity under Gift Aid also reduce your ANI in a similar way to an individual pension contribution.
Gift Aid payments are paid net of basic-rate Income Tax and so should be grossed up before you deduct them from your income.
An interesting way to look at this approach is that you are essentially gifting your Child Benefit to charity rather than having it clawed back in tax.
Get in touch
If you are affected by the Child Benefit charge, or you’d like to explore how pension contributions could reduce your Income Tax bill, please get in touch.
Contact us by email at email@example.com or call us on 01189 876655.