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Pension contributions could preserve Child Benefit

Pension contributions could preserve Child Benefit

Category: Pensions

This article was correct at the time of publication. It is now over 6 months old so the content may be out of date.

The decision to cut child benefit to higher rate tax payers could create a strong incentive for people to increase their pension contributions.

This is because somebody earning just over the higher rate threshold could take themselves out of the higher rate tax bracket by paying more into a pension, according to Towers Watson.

From 2013, when the money saving initiative is introduced, this could mean their family remains eligible for child benefit payments that could be worth thousands of pounds a year.

"From 2013, some families could find that putting more money aside for retirement increases the cash in their pocket as well as their pension fund," Paul Macro, a senior consultant at Towers Watson, said.

"The costs of raising children can prevent parents paying as much into their pensions as they feel they should. For some, it may now be a question of whether they can afford not to save more.

"For a family with three children, child benefit can be worth nearly £2,500 a year, tax-free."

Child benefit is paid at a rate of £20.30 per week for the first child and £13.40 a week for each subsequent child; these rates have been frozen for the next three years. In 2010/11, people start paying higher rate tax once their income exceeds £43,875.

An example of how increasing pension contributions could increase disposable income is below.

  • A couple have three children under 16. This means that their child benefit will be £2,449 a year if they qualify for it.

  • One partner earns £47,500 and has no other taxable income. The other either does not work or earns less than the higher rate threshold.

  • Currently, the higher earner pays 5% of their salary into an occupational pension, on top of the contributions that their employer makes for them. This £2,375 employee contribution reduces the salary assessed for income tax to £45,125.

  • £45,125 is £1,250 above the higher rate threshold. This parent is therefore a higher rate taxpayer, so the family would not qualify for child benefit from 2013.

  • However, the employee could choose to increase the contributions they make to their pension, paying an extra £1,250.

  • If taken as income, this £1,250 would be taxed at 40%. So paying it into a pension reduces the employee's take-home pay by £750.

  • However, it also means they are no longer liable for higher rate tax on any of their income. Because neither parent would then be a higher rate taxpayer, the family would now qualify for £2,449 of child benefit.

  • Overall, the employee could therefore boost their pension fund by £1,250 and their family's disposable income by £1,699.

The example above assumes the individual's employer offers an occupational pension scheme providing tax relief through 'net pay' arrangements, which allow pension contributions to come out of pre-tax income.

Individuals may also be able to preserve their eligibility for child benefit by contributing to a personal pension or by sacrificing part of their salary and instead receiving higher employer pension contributions, which do not count towards taxable income.

"If there is a simple cut-off point based on the tax band of the parent with the highest earnings, people will look at what they can do to push their income below the threshold," said Mr Macro.

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