PUBLISHED: 05:53 EST, 28 August 2012 | UPDATED: 06:33 EST, 28 August 2012
One in six higher earners expect to see their child benefit payments reduced when the planned child benefit tax comes into force in January next year, but some who act now could save themselves thousands.
The figure for how many expect to see their child benefit cut was revealed by research from Prudential, echoing the Institute for Fiscal Studies, which estimates that 1.2 million families will be affected by the change.
Higher-earning parents with three children could end up missing out on nearly £2,500 a year. But there's a clever, tax-efficient trick that should help you beat the child benefit tax, and boost your retirement savings. We take a look at how it works.
Tax trick: saving more into your pension could help you avoid the new child benefit tax
Paying larger contributions into a pension to push your total income below the threshold at which the tax kicks in stands to save you a considerable amount, as well as provide a big boost to retirement savings.
A quarter of higher rate tax payers expecting to see their child benefit payments reduced plan to use this method to avoid the tax, says Prudential.
What are the new rules?
Rather than simply not get child benefit, higher earning parents will get the payments but then have them deducted back via a tax lump sum payment.
From 7 January 2013, if one parent in a household earns more than £50,000 he or she will have to pay the new child benefit tax, regardless of which parent is claiming the child benefit and irrespective of the income earned by the second parent.
If both parents earn above the threshold it will still be the parent with the highest income who will face the charge.
Parents are due to receive a letter from HMRC in the autumn explaining what the tax will mean for them and what they need to do.
Currently families receive a child benefit payment of £1,055.60 a year for the eldest child and a further £696.80 a year for each additional child.
Therefore a high-earning family with three children under 16 could find themselves up to £2,449.20 a year worse off under the new rules.
Those who earn between £50,000 and £60,000 a year will be charged tax on their child benefit at a rate of 1 per cent for every £100 of their income over £50,000.
So, for example in a family with two children where one parent is earning £55,000, their child benefit of £1752.40 will be taxed at 50 per cent, leaving the family with £876.20.
When one parent earns over £60,000 the couple will receive no child benefit at all.
Because of the way the system is designed the parents will still receive their child benefit in full, but will be required to fill in a self-assessment form and will see the benefit, or a proportion of it, taken back off them as a lump sum at the end of each tax year.
'A real blow for families' Here's how to beat it
Matthew Stephens, Prudential's tax expert, said: 'The new child benefit tax charge will be a real blow for many families next year, particularly in households where salaries are unevenly distributed and one parent is the main or sole breadwinner.
'There is, however, a strong case for a parent whose income is between £50,000 and £60,000 to make additional pension savings to avoid the new tax, and at the same time boost their retirement income.
'Saving for retirement is absolutely vital, yet a quarter of higher rate taxpayers say they don't contribute anything at all to a pension scheme, which is very worrying.
'Often this is because people believe they can't afford to save, but as is the case for many families that will see their child benefit payments taxed from next year, not saving for retirement could be a far more costly option.'
THE TAX TRICK IN PRACTICE
Here we use an example of a family where Mr A's earns £55,000 a year and receives an additional income from investments of £5,000 a year and Mrs A doesn't work. They have two children under 16.
Mrs A claims the child benefit and gets £1,055.60 a year for the eldest child and £696.80 a year for the other two children - £2449.20 in total.
Left in this situation with a total income of £60,000, Mr A would pay back the full amount of child benefit in tax at the end of the year. However, if Mr A were to invest enough money into his pension each month he could avoid paying the tax altogether.
Because this is the first year the tax has been introduced and earnings are assessed from the April 2012 to 2013 tax year, he actually only has seven months in which to pay enough to his pension to bring his income down to £50,000 – September to March 2013 (the new tax year begins in April).
So effectively in seven months Mr A needs to invest £10,000 into his pension. This works out as £1,428 per month. Obviously in a full tax year, Mr A would only need to invest £833 a month into his pension.
To do this Mr A needs to contribute that amount from his pre-tax wages into his pension, but due to the wonders of tax relief it will not actually cost him £10,000.
To pay £10,000 a year in, Mr A would need to contribute £833 per month into a pension – this will take £60,000 taxable earnings down to £50,000.
However, that will only actually cost Mr A £6,000 as tax relief will mean that he gets £4,000 of that sum back (£2,000 in his pocket in a tax rebate & £2,000 paid directly into his pension by HMRC).
But it is important to remember that he will see his actual pre-tax income fall by £8,000 overall, as £2,000 of tax relief will go into topping up his pension & £2,000 directly back to him from HMRC.
He will also have to wait for that latter rebate and so will see pre-tax monthly income fall by £833. This is unless he is committed to making the same pension contributions every month, in which case he could write to his tax office and get his code adjusted so he pays less tax.
What this means is that to invest £10,000 a year into his pension would only really cost Mr A £6,000, and in addition his family would not lose the £2,449.20 child benefit.
So in total, Mr A is actually £6,449.20 better off.
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