On January 7th 2013 the Government introduced a new tax on Child Benefit for any individual parent with an income of £50,000 or more. The tax is tapered over the next £10,000 of income so that by the time the income reaches £60,000 it completely wipes out the Child benefit. For a family with one child that means extra tax of £1,056 per year, and for those with two or three children it’s as much as £1,752 & £2,449!
But it’s actually worse than that because you have already suffered income tax of 40% on the same income, meaning you’ve already paid £4,000 in tax on the £10,000. Assuming you have two children the total tax charge on you because you’ve earned that extra £10,000 is in fact a total £5,752, or 57.5%. Or for three children a staggering 64.5% of the income has been swallowed by tax, meaning you only receive £3551 in your pay packet.
I think we can all agree it’s not good.
So how can you beat the Taxman, and be better off yourself?
The answer lies in Pension provision, and the key is that as a 40% taxpayer you benefit from full tax relief on a Pension contribution. This comes in two parts, which I’ll cover in a moment.
Let’s assume you now contribute £10,000 into a Pension
1) The first part of the Tax relief means you only pay in £8,000, but £10,000 is added to the Pension, so you’ve clawed back £2,000 already, although you don’t see this.
2) The second part of your tax relief comes once you’ve completed your self assessment tax forms, where you’ll gain an additional £2,000. This bit goes back in your pocket.
So far you’ve spent £8,000, and got £2,000 back, so you are out of pocket £6,000.
Now here’s the best bit, as you can fully offset the £10,000 pension payment against your income, it effectively reduces your income to £50,000 which means you get to reclaim the Child Benefit tax charge of £2,449. If you deduct that from the £6,000 it means that you have gained £10,000 more in your pension pot for a net cost of £3,551.
When you retire you can take 25% of that back tax free too, so assuming it didn’t grow (which is unlikely) you’d receive another £2,500 of your Cash back, meaning that ultimately it only cost you £1,051 to generate an additional pension of about £375 per year for the rest of your life (assuming annuity rate of 5% on £7,500).
Or to put that another way it gives a return of nearly 36% per annum (although you do have to wait until you are older to get it!)
So you really can beat the Taxman at his own game!
But please remember before going ahead that you should speak to an adviser (click here for help in finding one) to make sure it’s the right thing for you to do for you and your family.
Financial Planning Designer
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