How your pension pot can help claw back lost child benefit | Money

Thousands of families are failing to take advantage of a little-known quirk in the tax rules which means that paying more into your pension gives you more child benefit.

Steve Webb, a former pensions minister, says large numbers of families where one parent earns more than £50,000 a year are “unnecessarily” losing out on child benefit. This “lost” cash could quite easily run into tens of millions of pounds a year.

It relates to the government’s so-called high-income child benefit charge, where the benefit is clawed back via the tax system if either you or your partner have an “adjusted net income” of more than £50,000.

It took effect in 2013 and has meant many thousands of people have lost some or all of the benefit, currently worth £1,788.80 a year for a family with two children (you get £20.70 a week for the eldest/only child, then £13.70 a week for each additional child).

In a nutshell you’ve a choice: carry on receiving benefit but pay extra tax through the self-assessment system; or give up the benefit and don’t pay.

The tax is 1% of the amount of child benefit for each £100 of income on a sliding scale between £50,000 and £60,000. For those earning more than £60,000 the charge is 100% – in effect you receive no child benefit.

Back in September 2013, Guardian Money highlighted the little-known connection between the child benefit tax charge and pension contributions. Many people may not realise that putting more money aside for retirement can push down your tax charge, which means you effectively keep more of your child benefit.

What you might think of as an income of £50,000 a year isn’t the same as the taxman’s definition. The child benefit tax charge is based on your adjusted net income. This is your total taxable income (ie, basic salary plus any benefits from your job such as a company car or private medical insurance, plus share dividend or rental income etc), minus things such as pension contributions and gift aided donations to charity. In other words, for the purposes of this exercise people can deduct the money they contribute to their pension from their headline salary.

The name of the game is to find completely above board and morally acceptable ways of getting your adjusted net income below the vital £50,000. The most obvious is to pay more into your pension – which is what people are always being told they should do, and hardly falls into the same category as funnelling cash into offshore tax havens.

As Citizens Advice (not an organisation renowned for endorsing tax dodging) says on its website: “Pension contributions are taken out of your income before you pay tax. This could therefore reduce the amount of income on which you have to pay tax to below the £50,000 limit.”

Any pension contributions made by an individual, whether it’s an occupational scheme or a personal pension, will reduce the final amount of adjusted net income. For example, you could pay additional voluntary contributions into your occupational scheme. With some employers, for every £1 you pay in AVCs the company will pay an extra 50p or even £1 – making it even more of a no-brainer.

“For a higher-earning family, putting money into a pension is already a very attractive option. But what they may not be aware of is the additional advantage of reducing the tax charge they face. This is another reason for families in this income bracket to prioritise pension saving,” says Webb, who is now director of policy at mutual insurer Royal London, which published an analysis this week.

The insurer gives the example of “Tony” who has a taxable income of £58,000. His wife has no income and they have two children, which results in them receiving child benefit of £1,788.80 a year. As Tony’s income is £8,000 over the threshold he faces a tax of 80% of £1,788.80 – ie, £1,431.04. That means the overall value of their child benefit has therefore been slashed to just £357.76.

But if Tony pays £6,400 into a personal pension this will be “grossed up” to £8,000 (what he paid in, plus the basic rate of tax). Take that off his headline income figure and his adjusted net income falls to exactly £50,000 – which means he escapes the clutches of the tax charge, saving £1,431. Assuming all of the pension contribution falls within the higher-rate tax band, he will also be able to claim an additional £1,600 in tax relief (20% of £8,000) through his tax return. So that £8,000 has in fact cost him just £3,368.96.

To put it bluntly, the result is that Tony’s got more money in his retirement pot and chancellor Philip Hammond doesn’t get to snatch his kids’ cash, so it’s a win-win.

Meanwhile, if you are nudging at the £50,000 threshold, pay rises can be tricky, so you may want to increase your pension contributions to stay just below this level.

There are also other ways of reducing your adjusted net income:

Consider using “salary sacrifice” and opt to have some of your pay paid in the form of childcare vouchers. “These are also taken out of your income before you pay tax, so your taxable income will also reduce,” says Citizens Advice.

Increase your charitable giving. When calculating your adjusted net income, if you made a gift aid donation during the relevant period you take off the grossed-up amount – ie, what you donated plus the basic rate of tax. So for every £1 of gift aid donations you made, take £1.25 from your net income.

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