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How parents can eliminate the child benefit tax charge

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Written by: Emma Lunn
30/09/2019
High earners can increase pension contributions or charity donations to reduce child benefit tax liability.

Parents have just a few days to notify HMRC if they will be affected by the high income child benefit charge for 2018/19 – otherwise they will need to file a tax return and pay any extra tax due by 31 January.

But financial planners LEBC say many parents earning between £50,001 and £60,000, when the benefit gets taxed, could reinstate their claim to all or some of the benefit simply by increasing their retirement savings.

New tax charge for parents

Child benefit is paid to the parents and guardians of children up to age 16, and children aged 16 to 19, if they stay in approved full-time education or training. It is £20.70 per week for the eldest child and £13.70 per week for each younger child.

The tax charge was introduced in 2013 and affects families where one parents earns more than £50,000 a year.

Those with income over this figure are required to pay 1 per cent income tax on the child benefit for each £100 of income above this. This means the value of child benefit is eroded to nil once the taxable income of one of the adults exceeds £60,000.

The rule change means a typical two-child family will be losing £1,788.80 a year.

Self-employed and single parents most affected

The tax charge is especially problematic for those with fluctuating pay, such as the self-employed or an employee with irregular hours or significant bonuses.

It also impacts single parents more severely as it only requires one person to have income over £50,000 to trigger the tax charge, so a couple could have joint income of up to £99,999 and keep child benefit but a single parent has half the allowance.

How to reduce the child benefit tax charge

LEBC says the tax on child benefit can be reduced, or even removed, for high earners by making either a pension contribution or charitable donation, both of which have the effect of reducing taxable income.

For example, let’s say Anna and John both work, and have an eight-year-old child together.

Anna earns £25,000 and John earns £52,000 – but bonuses mean he expects to earn £60,000 in total this year (although this can change year to year).

Child benefit of £1,076.40 a year is paid to Anna tax-free and she earns less than £50,000 so she is not taxed on it. But because John earns more than this he has been paying tax of £215 a year on the child benefit through PAYE. This year his bigger bonus would mean his extra tax bill will be £1,076.40 and he will pay tax of £12,576.

The couple have a choice of ceasing to claim child benefit, notifying HMRC of John’s pay each year, or completing a tax return and paying the extra tax through self-assessment.

But if John pays his £8,000 bonus into a pension plan, his taxable income will be below the threshold. There will be no tax to pay on the child benefit and the £8,000 pension contribution will be worth £10,000 in his pension due to tax relief. John’s income tax bill would be £9,500, and the net cost to the family of John’s pension savings of £10,000 would be £4,924.

Making charitable gift aid donations also has the same effect of eliminating the tax on the child benefit and relieving the gift at the taxpayer’s highest income tax rate.

State Pension credits

Another little-known side effect of waiving payment of the child benefit, to avoid the tax headache, can lead to loss of State Pension for a parent of children born after 2013, who is a full- time carer. This is because not claiming child benefit means a loss of credits for a parent’s State Pension.

Kay Ingram, director of public policy at LEBC, said:  “With each year’s credit worth £250 per annum of State Pension, that is a serious concern and impacts women disproportionately, widening the gender pension gap.”

State Pension credits can be restored by completing a CH2 form available from the Department for Work and Pensions website. To get the State Pension credits ,the claim for child benefit is made on CH2 but then the parent can waive payment of it. It is also important that the claim is made in the name of the non-earning parent or the credits will be wasted. It can only be backdated three months.

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