An income tax charge applies to people who get Child Benefit and whose income (or partner's income) is more than £50,000 in a tax year.
If income is between £50,000 and £60,000, the charge is a proportion of the Child Benefit received. If it's over £60,000, the amount of the charge is the same as the Child Benefit received. We explain below how to reduce or eliminate the charge.
Child Benefit isn't means tested - it's paid tax-free to most people with children, with no requirement to have paid National Insurance contributions at all.
It's important to note that Child Benefit itself isn't being taxed or reduced - it will continue to be paid in full to the claimant - usually the mother.
However, a tax charge will be applied via the tax return on any partner whose income is more than £50,000 a year. If both partners have incomes over the limit, the charge will apply to the partner with the higher income. The tax charge will be one per cent of the amount of Child Benefit received for every £100 of excess income. This is why the charge is the same as the Child Benefit received by people whose income is more than £60,000 a year.
The 'income' used by HM Revenue & Customs to calculate the charge is 'adjusted net income'.
The starting point is net income on which income tax is calculated. This includes employment income, income from self employment, pensions and investment income minus any trading losses and payments made gross to occupational pension schemes.
The next step is to deduct the gross amount of any Gift Aid contributions and the gross amount of any pension contributions that receive tax relief at source.
The final step is to add back in any tax relief for payments to trade unions or police organisations deducted when arriving at net income. The result is the adjusted net income.
So any pension contributions made by an individual, whether gross contributions to an occupational pension scheme or gross contributions to a personal pension, will reduce the final amount of adjusted net income. If this is enough to get it below £50,000, the charge will be avoided; if it ends up between £50,000 and £60,000, the charge will be reduced.
Tony has a taxable income of £58,000 and his wife Lucy has no income. They have two children which results in Lucy receiving Child Benefit of £1,788.80 p.a.
Since Tony's income is £8,000 over the limit, he'll face a tax charge of 80% of £1,788.80 = £1,431.04.
As a couple, the overall value of the Child Benefit has therefore been reduced to £357.76 (£1,788.80 - £1,431.04).
If he makes net contributions totalling £6,400 in the tax year to a personal pension plan, this will be grossed up to £8,000. This means that his adjusted net income falls to £50,000 and no charge is payable.
By contributing £6,400, he's saved £1,431.04. Assuming all of the pension contribution lies in the higher rate tax band, he'll also be able to claim an additional £1,600 in tax relief (20% of £8,000) through his tax return. So his £8,000 pension contribution has in fact cost him £3,368.96 (£6,400 - £1,431.04 - £1,600).
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All references to taxation are based on our understanding of current taxation law and practice and may be affected by future changes in legislation and the individual circumstances of the investor.