David Gow: Beat the cuts and keep child benefit

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PARENTS earning more than £50,000 a year are about to lose some or all of their child benefit – and some will be thousands of pounds worse off a year as a result.

If you have three children you stand to lose out on ­almost £25,000 in child benefit in ­today’s terms over the next decade, under reforms about to take effect.

Child benefit is a tax-free payment, given to parents of children aged under 16, aimed at helping parents cope with the cost of raising children. You can claim £20.30 a week for an eldest or only child and £13.40 a week for each child thereafter.

However, from 7 January it will start to be withdrawn for families in which at least one earner has adjusted net income above £50,000 at a rate of 1 per cent for every £100 of income above this through a tax charge. This means that if you or your partner earns more than £60,000 you’ll effectively receive no child benefit.

However, it is possible to take action to ensure you remain fully entitled to child benefit. Firstly, work out if you’re affected by the new rules, and then consider the options to beat them:

Are you affected?

How can you work out your adjusted net income (ANI)? It’s not as simple as just thinking about your salary.

The first step is to add up your taxable income. This should include gross income from employment, including any taxable company benefits; profits if you are self-employed; taxable social security benefits (including the state pension); other pension income plus savings and dividend income before tax is deducted at source. Do not include interest from tax-free savings, such as Isas, or profits from rental income.

Then deduct grossed up contributions to an occupational or personal pension plus any gift aid charitable donations. So, for every £1 of pension contribution or donation, take £1.25 off your net income. Also subtract trade losses, losses on qualifying property and interest on qualifying loans.

Boost your pension

So, you’ve found out you are affected by the rule changes. One way to mitigate this is through making pension contributions.

Take Alan and Barbara, who have three children aged under 16 and claim child benefit of £2,449.20 a year. Alan earns a salary of £48,000 and has also received a bonus of £5,000. He has no other taxable income, giving him total ANI of £53,000. He will incur a tax charge on the child benefit of 30 per cent (1 per cent for every £100 over £50,000) – so £734.76.

However, if Alan makes a net pension contribution of £2,400 this would be grossed up to £3,000 and deducted from his taxable income leaving him with an ANI of £50,000. This means that there is no tax charge to pay.

He would also be able to claim another £600 back in higher rate tax relief on the pension contribution, meaning the pension contribution would actually cost just £1,800. The total tax saving is £1,200 plus £734.76, giving £1,934.76. That means he gets an effective rate of tax relief of a mammoth 64.5 per cent. Result!

Donate to charity

Making a charitable donation can also help you to hang on to your full child benefit. Let’s look at another example. ­Edward and Freda have two children and are, until Monday, entitled to child benefit of £1,752.40 a year.

Edward earns £30,000 per year and isn’t caught by the new rules. However, Freda earns £50,000 from her job and has recently inherited a share portfolio of £100,000 which usually generates gross dividend income of £5,000 per year, giving her ANI of £55,000 – and making her liable to a tax charge of £876.20. If Freda makes a £4,000 donation to charity, this would be grossed up to £5,000, reducing her ANI back down to £50,000 and eliminating the tax charge.

Become a director

Another option is to become a director. Let’s take a third example. Gordon works as a self-employed sole trader while his wife, Heidi, stays at home to look after their four children. They receive annual child benefit of £3,146. Gordon has pre-tax net profits of £100,000, meaning their child benefit will be fully clawed back via a tax charge.

However, Gordon could change from sole trader to limited company status. He could become a director with a salary of £7,500 and his wife could work as company secretary and have a salary of £7,500, too.

They could each be 50 per cent shareholders and the company could pay out dividends each year. Going forward, they forecast £34,000 net dividends per shareholder per year. This would give each of them an ANI of £41,500 – below the £50,000 claw-back threshold.

Gordon and Heidi also have more after-tax income under this arrangement. The previous situation gave Gordon take-home income of £65,500. Now, through the limited company, they jointly have take-home income of £81,700, plus the £3,146 retained child benefit – more than £19,000 more.Heidi will also now qualify for National Insurance contributions, giving her state pension entitlement.

Call on grandparents

A final example: Ian, James and Kenneth. Ian is a grandparent whose wife passed away some time ago. He has one son James, who in turn has one son, Kenneth.

James is the only beneficiary of Ian’s estate, which is worth around the inheritance tax (IHT) threshold of £325,000. James has ANI of £62,500 and, therefore, will lose all of his child benefit, but has no money spare after family expenses to make a further pension contribution to mitigate this.

Ian has surplus income of £7,000 a year. Ian could gift £3,000 to James using the annual IHT exemption plus the £7,000 excess income, enabling James to make an extra pension contribution of £10,000 per year. This would be grossed up to £12,500, meaning that James incurs no tax charge on the child benefit. He can also reclaim higher rate tax relief on the pension contribution of £2,500 – without spending a penny – plus Ian reduces the potential IHT liability he passes to James ­after his death.

• David Gow is a chartered and certified financial planner at Acumen Financial Planning in Edinburgh, david.gow@acumenfp.com