As a reminder, where one parent earns above £50,000, a “high income child benefit tax charge” is levied on that earner with the effect that there is a 1% tax charge for every £100 that their income exceeds £50,000. By the time income reaches £60,000, the charge is equal to 100% of the child benefit:
- The recipient of child benefit may choose to stop receiving child benefit; or
- The “high earner” pays back some or all of the amount received by the family as a tax charge
We can observe the inequity that one household could have two parents each earning £49,999 per year and receive the full amount of child benefit and another household where one parent earns £60,000 per year and the other earns nothing but effectively receives no child benefit.
But assuming there is no opportunity to shift income between the parents, what options are available?
Those affected by this are able to reduce their “adjusted net income” by making personal pension contributions or gift aid donations to recover some or all of the tax charge.
- David and Claire have 2 children and receive £1789 of child benefit
- Claire earns a £60,000 salary, David stays at home to look after the children
- Under the high income child benefit tax charge Claire would have to pay back the £1789 child benefit as a tax charge
- However, if Claire made a personal pension contribution of £8,000 net (grossed up to £10,000 by the pension provider), this takes her adjusted net income back down to £50,000 meaning the child benefit is retained
- Claire will also be able to claim an additional 20% tax relief on the pension contribution through self assessment, paying £2,000 less income tax
- Claire has a pension fund of £10,000 which has cost her £6,000 net of tax relief
- The family gets to keep the £1,789 of child benefit
It’s worth noting that donations made by Gift Aid have the same effect as personal pension contributions so a combination of the two can work equally well.
Two birds, One Stone: Inheritance Tax planning for Grandparents helps their kids keep Child Benefit
But what if Claire and David don’t have £8,000 lying around to pay into the pension? Can anyone else help? What about the Bank of Mum and Dad?
Claire’s parents, Janet and Geoff, have more pension income than they need and enough in savings and investments to mean that they have an inheritance tax liability.
It’s not widely known that payments into someone else’s pension are treated as either exempt or potentially exempt gifts for IHT purposes by the donor. It’s probably less well known still, that for income tax purposes they are treated as if they were made by the pension scheme member, not the donor.
So, if Claire’s dad Geoff make a payment of £8,000 to Claire’s personal pension, the effect for Claire and David is the same as set out above but moreover, provided Geoff survives seven years from the date of the gift, the £8,000 will fall outside of his estate and save 40% inheritance tax on that amount (£3,200).
If Geoff has so much surplus income that he can do this on an annual basis then he may be able to claim that the gift is made under the exemption for ‘regular gifts from surplus income above normal expenditure’ – no seven year “clock” will apply, meaning the gift is immediately exempt (always keep detailed records if relying on this exemption).
As a general point, always include gift aid donations on your tax return if you are a higher rate taxpayer.