Our recent article, ‘6 top tips for the end of the tax-year’ has been extremely popular.
One of the tips though is so effective we wanted to highlight it separately. So, if you have children and you or your partner earns over £50,000 each year, read on, you might just be able to reclaim some, or all, of your lost Child Benefit.
But, first things first.
Why have you lost your child benefit?
As part of the austerity program, the Government has decided to cut Child Benefit, where one person in a household earns more than £50,000 each year.
The new rules mean that where one parent earns between £50,000 and £60,000 per year the benefit is reduced by 1% for every £100 of income above £50,000. However, when a parent earns above £60,000 per year, Child Benefit is completely withdrawn.
Parents are therefore hit twice; they are paying 40% tax on their earnings and losing some or all of their Child Benefit, massively pushing up the effective rate of tax as this table shows:
|Number of children||Child benefit lost each year||Effective tax-rate paid||Total tax-rate|
But all is not lost, there is an answer!
How can your pension help you reclaim lost Child Benefit?
A pension is for retirement, right? Yes, of course it is, but if you are affected by these changes, it could also hold the answer to you being able to reclaim some or all of your lost Child Benefit.
Let us explain.
The income used to calculate whether you will lose any of your Child Benefit is actually your ‘adjusted net income’. This is calculated by taking your gross pay and making certain deductions, including pension payments and charitable donations.
So, if you earn above £50,000 each year, making a pension contribution could reduce your ‘adjusted net income’ to below the level where your Child Benefit is removed.
What’s more, you will also receive 40% tax-relief on your pension contribution; neatly reversing the double blow we mentioned earlier.
How does this work in practice? Here’s an example:
John and Jane have four children. Jane earns £50,000 and John earns £60,000.
John pays 40%, or £4,000 tax, on all of his income between £50,000 and £60,000. If John does nothing and makes no pension contributions they will lose their Child Benefit, either directly or through a tax charge.
In the 2013/14 tax-year this means John is effectively paying tax of £7,146 on the band of earnings between £50,000 and £60,000.
However, there is a way round this, if John makes a pension contribution of £8,000. This has the following benefits:
- The £8,000 pension contributions benefits from tax-relief, which increases it to £10,000
- An additional £2,000 tax-relief can be claimed by John, taking the net cost of a £10,000 pension contribution down to just £6,000
- John’s ‘adjusted net income’ is reduced to £50,000 which means the household will continue to receive Child Benefit with no reduction
To summarise, John has now got £10,000 in his pension fund which will grow tax-efficiently and boost his income in retirement.
Remember too, this contribution only cost him £6,000 and he can claim £3,146 in Child Benefit which would have otherwise have been lost.
To put it another way, he has paid out £6,000 to gain £13,146; not a bad deal!
“But I don’t have any money to put into a pension”
It’s true that with the rising cost of living and stagnant wage growth, many people don’t spare money lying around to pay into a pension, but remember:
- Even if you make a smaller pension contribution, you will still be able to reclaim some of your lost Child Benefit and you will qualify for tax-relief on your contribution
- You could moving money from other savings or investments. If you do this remember that any money you put into a pension is tied up until you are at least 55, rising to 57 from 2028, although if the proposed changes in the Budget take effect, you will have more flexibility to withdraw money when you retire
- More people than ever are using an ISA (Individual Savings Account) to plan for their retirement. That can work well, but the contributions won’t help to reduce your ‘adjusted net income’ and they don’t qualify for tax-relief. Everyone’s circumstances are different and you should take advice before making a final decision, but perhaps you should consider diverting contributions from your ISA to a pension, if this will help you reclaim lost Child Benefit?
Remember too, if you are already making pension contributions these should be declared so the corrected ‘adjusted net income’ figure is used.
A pension can really help
Of course a pension is for retirement, but making contributions can also help your finances now.
If you would like to know more about reclaiming your lost Child Benefit by making pension contributions then talk to one of our advisers.