In the United Kingdom, a beneficial form of aid known as child benefit is disbursed to families. Payments of 1,133.60 pounds for the first child and 751 pounds for each additional child are deposited regularly. To illustrate, total child benefit would be 1,134 pounds for one child, 1,885 for two children, 2,636 for three, and for four children, it would be 3,388 pounds.
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Optimizing Child Benefit with Pension Contributions
You can claim child benefits until your children turn 16 or up to 20 years old if they are still enrolled in approved educational programs, not including university degree courses. However, an issue arises for families with earnings above 50,000 pounds, as the child benefit starts getting clawed back. For every 100 pound increment a higher earner makes over the 50,000 pound limit,a tax equivalent to one percent of the child benefit is charged.
Suppose a family with two children has an income of 51,000 pounds, then a tax of 188 pounds, which is ten percent of the child benefit, is levied. When the income escalates to 60,000 pounds or more, the entire child benefit is ultimately withdrawn. It is also an option to opt-out of claiming child benefits to avoid this income tax.
How to Circumvent the Child Benefit Charges?
One of the simplest methods to circumvent this is by making a pension contribution, which reduces your adjusted net income, and hence may yield above-average tax relief.
To exemplify this, consider Fred who earns 60,000 pounds annually, his wife Sheila earns 30,000 pounds, and claims child benefit for their three kids amounting to 2,636 pounds. At this income, Fred falls into the bracket of a higher tax rate and pays 40% tax on the top 5,000 pounds between 55,000 and 60,000, resulting in a 2,000 pound income tax bill. Additionally, there is a child benefit charge of 1,318 pounds which is 50 percent of the family’s child benefits. This means that Fred’s actual income, after accounting for these deductions, results in 1,682 pounds.
If Fred decides to contribute 4,000 pounds into his pension plan, the taxman (HMRC) will add 1,000 pound basic rate tax relief, making the gross pension contribution 5,000 pounds. This process is automatically done via most pension schemes. Fred would then have to file a tax return to get another 1,000 pounds as higher rate tax relief.
This contribution reduces Fred’s adjusted net income from 60,000 to 55,000 pounds, reducing his child benefit charge by 1,318 pounds. Therefore, in effect, Fred gets, 3,318 pounds of tax relief on his 5,000 pension contribution, equivalent to 66% of it. Fred ends up with 5,000 pounds in his pension pot as opposed to 1,682 pounds of after-tax income.
This scenario demonstrates that parents within the income bracket of L50,270 and 60,000 pounds could benefit significantly from tax relief on pension contributions – 51% with one child, 59% with two children, and 66% with three children, compared to the 40% tax relief enjoyed by other high-rate taxpayers.
Optimizing child benefit with pension contributions presents a strategic opportunity for parents to bolster both their retirement savings and their children’s financial security. By channeling child benefit funds into pension contributions, parents can leverage these resources to build a more robust financial foundation for themselves and their families.
Furthermore, this approach highlights the importance of proactive financial planning and maximizing available resources to achieve long-term financial goals. By embracing this strategy, parents can navigate the complexities of financial management with confidence, ensuring a brighter and more secure future for themselves and their children.
