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Five ways to offset the raid on child benefit

Your Money
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Your Money

Parents impacted by the child benefit changes may be able to ease the pain through organising their affairs in a tax efficient way.

This week saw thousands of families with one earner earning above £60,000 opt out of receiving Child Benefit or face a tax charge later to pay back the full amount.

According to investment advisory firm, Bestinvest, at £20.30 a week for a first child and £13.40 per additional child, a family with three children caught by the new rules faces the prospect of being £2,450 worse off a year (£47.10 per week), broadly equivalent to nearly a £4k pay cut for a 40% taxpayer.

Jason Hollands, managing director at Bestinvest, looks at a number of ways that parents who have been impacted by the changes may be able to ease the pain through organising their affairs in a tax efficient way.

Utilise ISA allowances for you and your spouse:

Using up your ISA allowance is the most obvious place to start. Currently you can invest up to £11,280 per annum in stocks and shares ISA or £5,640 in a cash ISA.

Interest rates may be low at the moment so cash ISA rates at 2 – 2.75% AER are not especially high, but they are still sheltered from the taxman.

Plus, if you have a longer view (more than 5 years), you might like to take on more risk and go for a stocks and shares ISA.

With UK equities yielding around 4%, the tax efficiency of an ISA is attractive for those subject to the higher rates of tax and the benefits should accrue over time.

Don’t forget to use the allowance for both you and your partner.

Max up your pension contribution:

Pensions have had some tough press recently as politicians target them as a potential source of plugging the public finances.

Last month the Chancellor announced in his December Autumn Statement that the maximum annual allowance for gross contributions will be reduced from £50k to £40k in 2014 and, not to be left out, Labour have proposed abolishing the higher rates of tax relief on pension contributions altogether for those earning more than £150k per annum.

If you are currently paying income tax at the 50% rate, and it makes sense for you to invest in a pension, there is a compelling case to do so before 6 April since currently you will get effective relief of up to 50% whereas from 6 April it drops to 45% as a result of the scheduled reduction in the Additional rate of tax announced in the last Budget.

Pension tax relief works by grossing up your contribution by basic rate tax to enhance the value of the fund but those in the higher and additional rate tax bands are able to make a further reclaim for the balance between the basic rate and their marginal rate via their annual tax return.

There is no guarantee that such generous reclaims will last forever.

For a family set to lose £2,450 of child benefit and subject to 40% income tax, a net pension contribution of £9,800 will be grossed up to £12,250 in the pension plan but a further £2,450 could be reduced from their tax bill via self-assessment. 

Transfer assets to lower or non-earning spouses:

If you are married or in a civil partnership then consider transferring assets from the higher earner to the lower or non-earning partner to reduce the household tax liability.

If your partner does not work, you could turn a big chunk of taxable income into tax free income by utilising their annual personal allowance (currently £8,105 and set to rise next year to £9,205).

Of course, it is vital to realise that you are legally passing all ownership to them, so this is not a decision to be taken lightly

Make use of capital gains allowances to recycle assets into ISAs or pensions:

Each individual can bank profits on non-tax wrapped investments of up to £10,600 this year without liability to Capital Gains Tax. This is however one of the more overlooked allowances.

If you don’t have sufficient new cash to invest in an ISA or pension this tax year but do own shares or funds outside of these tax efficient structures, do consider selling or part selling these to utilise your capital gains allowances and recycling the assets into more tax efficient wrappers.

Specialist tax efficient investments:

For those who already have or would normally fully utilise the more mainstream allowances above, there are a number of investment schemes which carry statutory tax incentives. These include VCTs, EIS and Seed EIS.

The first two attract an income tax credit of 30% on investment in new shares, providing they are held for at least five years (VCTs) or three years (EIS), and the much higher risk Seed EIS scheme attracts and income tax credit at 50%.

In each case there are a myriad of tax benefits designed to provide incentives for the higher risk nature of these schemes but these should only be considered by investors who understand the risks and already have a well-balanced portfolio.

Don’t be dazzled by the cocktail of tax benefits if the underlying investment doesn’t stack up.

Hollands adds: “There are a number of ways in which you can organise your affairs in a tax efficient manner which may help offset the loss of child benefit.

“None is however a magic bullet as they will either require the availability of existing assets to be used for new investments or deployed elsewhere, with some of these schemes involving risk to capital.

“Furthermore any tax credits will only flow through at a later date once you have submitted your annual return.”