Fight back against the child benefit cuts

The Chancellor's plans to axe child benefit will come as a blow to many parents, but you may not have to lose out.

The Chancellor’s recent announcement regarding scrapping child benefit for higher rate taxpayers has certainly been controversial. Under current rules, the benefit is available to all families no matter how high their household income. But new plans, due to come into force in 2013, will see that change so that any family where one parent earns more than £43,875 a year will have to wave goodbye to this extra cash.

Controversial cuts

You could argue higher earners don’t need state benefits. But the trouble with these proposals is that a family where both parents earn £40,000, and therefore have a total household income of £80,000, would still be eligible for child benefit, whereas a family with one parent earning a salary of say, £45,000, while the other parent earns absolutely nothing, wouldn’t qualify. The proposal appears totally unbalanced in this respect.

Right now, all families are entitled to a payment of £20.30 a week for their first child and £13.40 a week for each other child. If you had two children, total child benefit payments would amount to more than £1,750 each year.

It’s estimated this particular austerity measure will save the government a massive £1 billion and affect around 1.2 million families. But this number is expected to rise as more people climb into the higher rate tax bracket. You can find out more about these proposals in What the Child Benefit cut means for you.

How can you fight back?

If your earnings fall just into the higher rate tax bracket, there’s a clever way to ensure your entitlement to child benefit remains in place. In simple terms, you’ll need to reduce the amount of salary you earn for income tax purposes to preserve your family’s right the child benefit.

You can do this in a number of ways. For example, buying private medical insurance, and childcare vouchers directly from your gross salary will effectively reduce the amount of take home pay. This type of salary sacrifice has the potential to push your salary down to the basic tax rate bracket, making you eligible for child benefit once again.

How can your pension save child benefit for your family?

Another way of achieving the same effect - which I’ll focus on in this article - is to bring your salary down by making extra pension contributions into your employer’s pension scheme.

The example below, from Towers Watson, shows how this could work in practice. Note that the figures assume your employer offers an occupational pension scheme where tax relief is provided through ‘net pay’ arrangements. This enables pension contributions to be made out of pre-tax income.

Alternatively, it may be possible to achieve a similar effect by sacrificing part of your salary in return for higher pension contributions from your employer, which are not deemed taxable income. You find out more about using salary sacrifice in this way in Boost your pension for free!

The figures

So to return to the example:

Let’s say you have three children under 16 which means, if you’re eligible, total child benefit payments for a year run to £2,449. You, as the higher earning parent, earn a salary of £47,500, while your partner does not work.

You pay a personal contribution of 5% of your salary into your employer’s pension scheme. The contribution is therefore worth £2,375. By making this pension payment, your earnings are reduced by £2,375, which pushes down your salary assessed for income tax to £45,125.

But earnings of £45,125 are still £1,250 above the higher rate threshold of £43,875. This means you remain a higher rate taxpayer, and despite being the sole earner, you won’t qualify for child benefit from 2013.

However, you can preserve your entitlement to child benefit by stepping up your pension contributions. To achieve this, you would simply need to put an extra £1,250 into the pension scheme.

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Taking this amount as ordinary income would normally be liable to tax at 40%, but paying it into a pension instead reduces your take home pay by £750, meaning you’re no longer liable to pay higher rate tax on any of your income. (Don’t forget, the total pension contribution is worth £1,250 with 40% tax relief, but you only need to pay £750 out of your own pocket).

Your family therefore now qualifies for £2,449 of child benefit. Better still, your pension has been boosted by £1,250, while your family’s income has increased by £1,699 (calculated as £2,449 of child benefit minus the £750 extra pension contribution).

This technique provides double benefits: Maintaining your entitlement to child benefit while increasing your pension contributions. And given that many of us aren’t saving anywhere near as much as we should for our retirement, this can only be a good thing.

The drawbacks

Of course, if your earnings are significantly above the higher rate tax threshold, reducing salary in this way into your employer’s pension scheme may not be feasible for you in terms of affordability. After all, money directed out of your take home pay and into your pension will be locked away until you draw benefits at retirement.

You’ll also need to bear in mind that any future increases in salary may push your earnings back into higher rate tax bracket, and lead to the withdrawal of child benefit at this point. If that happens, you’ll need to decide whether increasing your pension contributions further in the way outlined above makes good financial sense for you and your family.

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