From January 7th 2013 the UK Child Benefit is subjected to an income test and progressively clawed-back from households where someone earns more than £50k pa. Where someone earns more than £60k this is clawed back in full. This has already been the subject of much discussion and I won’t go over old ground here as my blog is to provide strategies/solutions and not complain about policy or find reasons why any government “got something wrong, or got something right”. The policy is what it is, so…
What can we do about it? (Please read on even if you earn more than £60k!)
If your earnings are between £50k and £60k you effectively face a ramped-up marginal income tax rate. For a family with 2 kids, your 2012 child benefit was £1,752. In this example, for every £1 above £50k you earn, you would lose £0.60, from income tax (40p), national insurance (2p) and HICBC (18p for a full year with 2 kids, calculated by dividing £1,752 by the £10,000 window between £50k and £60k). Which obviously means you will only keep 40 pence of that hard earned pound!
As your earnings increase above £60k this 60% marginal rate obviously drops as the claw back will never exceed the amount of the Child Benefit you received
You can make some of your earnings effectively invisible!
“Earnings above £50k” actually means “adjusted net income above £50k”. Income includes all sources of income including salary, benefits in kind, gross interest, net rental income and so forth, but there are 3 main ways to reduce your “adjusted net income” to below £60k:
– Childcare Vouchers. Currently you can buy up to £243 in vouchers per month if your employer supports the scheme. Not only is this tax efficient and you reduce the costs of childcare, but this is £2,916 you can take off your income figure when it comes to calculating adjusted net income
– Charitable Contributions. Money donated to charity can also qualify here
– Pension contributions. Money invested in pensions is the most flexible option here. If your income is £55k and you made payments into your pension of £5k, you would keep your child benefit and have £5k in your pension. If you hadn’t made that pension contribution, you would have effectively only taken home £2,000 of the £5,000. Same principle applies for someone earning £85k – by putting £35k into a pension you would keep your child benefit and save income tax and national insurance on the contribution
So what’s the plan?
Well, for the 2012 tax year, because the change only happened in January, it might be worth taking a different approach than for 2013. In 2012, you would only stand to lose a quarter of the annual child benefit (which for 2 kids is £438, not the full £1,752), so it’s worth considering maximising earnings in 2012 but seek to reduce income in 2013 – ideally by effectively “capping” income at £50k by transferring excess income into a pension.
– 2012 marginal tax rate between £50k-£60k is 46.4%. This comprises: income tax 40%, NIC 2% and HICBC 4.4% (£438 divided by £10k)
– 2013 marginal tax rate between £50k-60k as already discussed is 60%
This does mean that for many, they will now need to complete a tax return online which I am sure will put lots of people off this approach.
A further problem arises because for those with aggressive early retirement plans you will take home less money as more income is diverted into your pension, which means you have less to put into ISA savings. More on this to follow in another post about ISA vs Pensions when considering very early retirement
Please let me know if you have any comments or feedback, and don’t forget that this is not financial advice! Read more in my disclaimer at the top of the page