Over a pint (or eight to be precise – I’m feeling the effects as I type this) last night, we talked about how to save child benefit, not the most exciting subject, but my two friends (each have two children) are just about to lose £1700 or so a year, which could easily be recovered through a small, cunning financial plan.
From 2013, child tax credit will be taken off those who pay higher rate tax. This year, the threshold for higher rate tax is £42,475. At the moment, the threshold for 2013 hasn’t been announced, so for the purpose of this explanation, let’s assume it stays the same. The situation is simple, if taxable income is above the threshold, by even a pound or so, then the £1700 child benefit will be lost.
This situation applies where one parent earns above the threshold, so if a couple earn say £22,000 each, they get to keep the child benefit. Unfair, I know, but those are the rules!
The situation is simple, if they do nothing, they will lose the £1700 child benefit, but with a good plan, they can keep the child benefit, and boost their retirement plans at the same time.
A pension contribution ‘extends’ the personal allowance by the gross amount paid into the pension. Here’s an example:
Joe Bloggs earns a salary of £43,000, he has two children, so also receives £1752.40 in child benefit.
Same salary, but because it is £525 above the higher rate tax threshold, the £1752.40 is lost!
Joe pays a one-off gross amount of £526 into his pension, he immediately gets tax relief at the basic rate at 20%, so he writes a cheque out to his pension provider for £420.80. The effect of the contribution is such that his personal allowance of £7475 is extended by £526, so is now £8,001. The next £35,000 is taxed at the basic rate, so the total Joe can earn at the basic rate of tax is now £8,001 plus £35,000 = £43,001. Joe therefore does not pay higher rate tax.
In the example above, Joe has now got an additional £526 saved for his retirement, but most importantly, gets to keep his child benefit. This means that Joe is £1,331.60 better off, after taking account of the pension contribution.
Click the link below for some examples of possible future values of the above contribution into a Stakeholder pension, but the same could be achieved through an employer sponsored scheme.
As always, wherever possible, take independent financial advice. Please don’t take this explanation as advice, just some food for thought!