Pension planning to retain child benefit and the personal allowance

Last month we looked at the importance of inheritance tax planning given that the nil rate band has been capped at £325,000 since 2008/09 and as announced in the Spring Budget, it will remain at this level until the 2025/26 tax year – that is a total of 17 years!

It was also announced in the Spring Budget that the income tax personal allowance and higher rate threshold will be frozen at £12,570 and £50,270 until the 2025/26 tax year.

In addition, the thresholds for losing entitlement to Child Benefit and the personal allowance, £50,000 and £100,000 respectively, remain at these levels meaning that these will be impacted by increasing income.

Child Benefit

An individual who had an income of £50,000 at the end of the 2020/21 tax year would not have been subject to higher rate tax and would have retained all of their child benefit. However, should that same individual’s income increase by say 4% per annum for five years, their income will have increased to £60,833 by 2025/26. A consequence of this is that they will have over £10,000 of income in the 40% threshold and lose entitlement to their child benefit in full.

The impact of this, taking account of the increase in the higher rate tax threshold from £50,000 in 2020/21 to £50,270 in 2021/22, is as follows:

Year	Income	Marginal rate	HRT income	Child Benefit
2020/21	£50,000	Basic	£0	Yes
2025/26	£60,833	Higher	£10,563	No

As a reminder, the High Income Child Benefit Charge (HICBC) came into effect from 7 January 2013 and is based on ‘adjusted net income.’ Generally, this is total taxable income, so before deducting any personal allowances, less any gross pension contributions which have received relief at source and gross gift aid payments.

The HICBC applies where a person is in receipt of Child Benefit and they have adjusted net income of between £50,000 and £60,000. The amount of the charge is a 1% deduction of the amount of Child Benefit for every £100 of income which exceeds £50,000.

From 12 April, Child Benefit increased to £21.15 (by 10p) per week for an eldest/only child and to £14.00 (by 5p) per week for any additional children.

And as mentioned above, even though in this tax year we have seen a slight increase in the higher rate tax threshold, the HICBC will still be payable once adjusted net income exceeds £50,000, and so for the first time ever this will impact basic rate taxpayers who otherwise would not have been affected by the charge and if their income continues to grow they will continue to be affected.

If, however, an individual were to consider making a pension contribution (whether to an occupational pension scheme or a personal pension scheme) or making gift aid payments, this would have the effect of reducing their ‘adjusted net income’ in order to retain some/all of the Child Benefit.

Case Study

Maria has taxable income of £59,000 and her husband, Phil recently decided to give up work to look after their two young children.

As they have two children, Maria receives Child Benefit of £1,827.80 a year, ((£21.15 + £14.00) x 52).

However, as Maria’s income is £9,000 over the £50,000 limit, she will face a HICBC of 90% - so £1,645.02. This in turn means that the overall amount of Child Benefit she will receive will therefore be reduced to £182.78 (£1,827.80 - £1,645.02).

If Maria were to make a gross personal pension contribution of £9,000 (£7,200 net) in the current tax year, her adjusted net income would reduce to £50,000. This means that not only will she retain the full amount of the Child Benefit of £1,827.80 but she would also save 20% income tax through self-assessment on the gross pension contribution which falls in higher rate tax - £1,746 (i.e. £8,730 x 20%).

This simply shows the benefit of carrying out pension planning (or gifting to charity), but individuals also ought to be aware that there are other benefits of claiming Child Benefit, namely:

• the ability to qualify for National Insurance credits which count towards the State Pension;
• the ability to qualify for other benefits, such as Guardian’s Allowance; and
• juvenile registration, that is, the process whereby children are automatically allocated a National Insurance number shortly before their 16th birthday.

Impact on personal allowance

In addition, it is inevitable that an increasing income will also cause a tax consequence as long as the £100,000 threshold for losing personal allowance remains fixed. The personal allowance is reduced by £1 for every £2 above this threshold which means that someone with an income of £125,140 or more will lose full entitlement to their personal allowance.

In the following example, an individual who had an income of £100,000 in the 2020/21 tax year would have retained their full personal allowance (PA). However, let’s consider the position if the threshold is not increased for the next five years, again with a 4% income increase. 

Year	Income	Lost PA	Tax on lost PA
2020/21	£100,000	£0	£0
2025/26	£121,666	£10,833	£4,333

 

Again, in these situations, an individual can make a pension contribution (whether to an occupational pension scheme or a personal pension scheme) which would have the effect of reducing their adjusted net income in order to retain benefit of their personal allowance, whilst also obtaining higher rate tax relief on the contribution.

Case Study -

Burt had income of £99,500 in 2020/21. This meant that he benefitted from a full personal allowance. Following a pay increase his income went up to £104,500 in the current tax year. The effect of this is that Burt’s personal allowance is reduced to £10,320.

This is calculated as follows:

£104,500 - £100,000 = £4,500

£4,500/2 = £2,250

£12,570 - £2,250 = £10,320

His income tax liability would therefore be as follows:

Income                        £104,500
Less PA                       (£10,320)
                                    £94,180

£37,700 x 20%            £7,540
£56,480 x 40%            £22,592
                                    £30,132

If Burt were to make a gross personal pension contribution of £4,500 (£3,600 net) this would mean that his adjusted net income would reduce to £100,000 so he would benefit from a full personal allowance and in addition, the basic rate threshold would be extended from £37,700 to £42,200 in providing him with higher rate tax relief on the contribution.

Income                        £104,500

Less PA                       (£12,570)
                                    £91,930

£42,200 x 20%            £8,440
£49,730 x 40%            £19,892
                                    £28,332

The difference of £1,800 (i.e. £30,132 - £28,332) simply illustrates the further 20% tax saving on the pension contribution (£4,500 x 20% = £900) plus the higher rate tax saving on retaining the lost personal allowance (£2,250 x 40% = £900).

This article provides a brief overview of a planning option available to individuals who may otherwise be affected as a result of these allowances, thresholds and rates being unchanged for next five years.