How child benefit tax is an advantage for pension savers

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In tax law, as one door closes, inevitably one somewhere else opens – and that’s the case for higher rate taxpayers facing child benefit cuts under new welfare rules.

An estimated 25% of wealthier taxpayers expect to have their child benefit payments cut or withdrawn completely – but families with a single breadwinner earning between £50,000 and £60,000 a year can beat the system.

Independent research commissioned by pensions giant the Prudential estimates thousands of taxpayers can preserve their child benefit payment and boost their pension contributions at the same time.

From January 7, 2013, if one parent in a household earns more than £50,000 a year, then the new child benefit tax is due, regardless of who claims the benefit and how much the other parent earns.

Pension contribution cancels out tax

The Prudential survey of workers paying income tax at a rate of 40% or more revealed 16% expect to lose some or all of their child benefit as a result of the new tax. That adds up to around 144,000 households.

However, one in four expect to increase their monthly pension contributions to avoid paying the tax.

Now families are paid child benefit of £1,055.60 a year for the eldest child and £696.80 a year for each additional child. A high-earning family with three children under 16 could lose up to £2,449.20 a year under the new rules.

Paying that cash in to a pension not only attracts pension contribution relief at 40% or more, but also cancels out the new tax.

Family is no worse off

Effectively, what a household would lose in child benefit is switched in to a pension and topped up with tax relief by the government. The family is no worse off because the child benefit would have been lost anyway.

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 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.”

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