Pensions and the High Income Child Benefit Charge

Child benefit recipients with income greater than £50,000 are subject to an income tax charge. The high income child benefit charge (HICBC), as it is known, is calculated as 1% of the child benefit received in the tax year for every £100 of income between £50,000 and £60,000.

Income of £50,100, therefore, results in a charge of 1% of the benefit received. Income of £50,200, results in a 2% charge … and so on. Income of £55,000 – with 50 lots of £100 above £50,000 - results in a 50% charge, and income of £60,000 or above results in the maximum tax charge equal to 100% of the child benefit.

The charge applies to couples and single parents. However, with couples the income of the highest earner is taken, irrespective of who the child benefit is paid to.

There are two approaches to dealing with the HICBC: (1) receive the child benefit and pay the charge or (2) cease claiming the benefit, in which case there will be no tax charge.

If the highest income (or sole income for a single parent) is below £50,000, the child benefit will be claimed as there is no tax charge. If the highest income is between £50,000 and £60,000, the first approach should be used as otherwise the full benefit would have been given up because of a partial tax charge. If the highest income is above £60,000 either approach can be used. Not claiming child benefit and avoiding the tax charge makes sense for those who are sure they will have income above £60,000. Claiming the child benefit and paying the HICBC insures against the possibility that a fall in income below £60,000 or even below £50,000 (perhaps because of redundancy) occurs by which time it will be too late to make a backdated claim for child benefit.

Any tax charge is due by 31 January after the end of the tax year concerned. For the 2019/20 tax year that means 31 January 2021. The maximum child benefit and consequently the maximum HICBC, based on a family with 2 children, will be 52 x (£20.70 + £13.70) = £1,788.80.

Rather than settle the tax liability directly, some clients might be in a position where they can plan ahead and utilise personal pension contributions to mitigate the charge. The reason personal pension contributions can help to mitigate the charge is because the income measure that is used is the familiar ‘adjusted net income’. This is total taxable income (before deduction of the personal allowance) less personal contributions to ‘relief at source’ pension schemes (mainly personal pensions) and gift aid donations.

Rather than settle the tax liability directly, some clients might be in a position where they can plan ahead and utilise personal pension contributions to mitigate the charge.

Example

Geoff’s salary is £55,000 in 2019/20. His partner is a non-taxpayer and together they have 3 children. Their maximum child benefit in 2019/20 is £2,501.20. However, because of Geoff’s income, a HICBC of £1,250.60 will apply.

If Geoff can reduce his ‘adjusted net income’ he can reduce or even eliminate this potential tax charge.

If Geoff pays £4,000 net in 2019/20 (a gross amount of £5,000) either in one payment or as regular contributions to a personal pension his adjusted net income will be £50,000 rather than £55,000. The result is that he will suffer no HICBC as his income for this purpose will not be greater than £50,000.

What’s more as he is a higher rate taxpayer, he will be entitled to a further 20% tax relief on his contribution. This returns £1,000 (20% of £5,000) to him following self-assessment, which means the contribution will ultimately have cost him £3,000 (net £4,000 - £1,000 = £3,000).

If Geoff can reduce his ‘adjusted net income’ he can reduce or even eliminate this potential tax charge.

This client will be able to eliminate a £1,250.60 HICBC by paying £3,000 from his own funds to a personal pension. The tax charge may be a lower amount than the contribution but it is ‘dead’ money, which will never be recovered. The pension contribution, on the other hand, as well as reducing the tax charge, has all the benefits of a contribution to a registered pension scheme: tax relief up front, tax-free investment growth and tax-free cash and flexible access from age 55.

If the above client instead makes a £5,000 net pay contribution to an occupational pension scheme he would gain the same overall advantages. The contribution would reduce his taxable pay, and therefore adjusted net income, from £55,000 to £50,000. He would benefit from 40% tax relief immediately, reducing the cost of the contribution down to  £3,000 and eliminating the HICBC.