Pension alert: Avoid 40% tax and child benefit ‘double whammy’ with pension contributions

A freeze to the higher rate band has thrust many British workers into a precarious tax position, but there may be a workaround. Personal pension contributions could hold the key to lower tax bills and increased benefits.

The Government decided last spring to hold the higher rate tax threshold at just over £50,000.

Analysis by the House of Commons Library found more than 1.2 million additional workers will find their earnings going over the 40 percent tax threshold as a result.

Amid the cost of living squeeze, Kate Smith, Head of Pensions at Aegon, explained the challenges facing more families who are dragged above the thresholds.

She said: “By 2026 over one million more people will be dragged into the higher rate tax band due to the freezing of tax thresholds at £50,270.

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“This doesn’t only mean that more people will pay more tax, but that families may face a double whammy by also losing out on valuable child benefit as earnings rise.”

In January 2013, the Government introduced new tax rules for high earners who receive child benefit.

The new rules meant that where an individual or their partner has pre-tax income of more than £50,000 a year, their entitlement to child benefit is impacted by a tax charge.

Where pre-tax income is between £50,000 and £60,000 a year, individuals claiming child benefit have to pay part of it back.

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If pre-tax income is higher than £60,000 a year, the whole amount has to be repaid to HMRC.

Losing out on child benefit could be a huge blow to households across the country.

Child benefit is paid at £21.15 per week for someone’s first (or only) child, which adds up to £1,099.80 per year.

An extra £14 per week is paid for any additional children, or £728 per year.

Therefore a household with two children could be losing out on more than £1,800 if they have their child benefit stripped away.

Ms Smith is not holding out much hope that the child benefit thresholds will change any time soon, leaving over a million more families in a tricky position.

She said: “These ‘High income child benefit’ thresholds have been frozen now for eight years, dragging more people into scope and losing out child benefit payments.

“There seems little likelihood that the thresholds will be increased while income tax thresholds are frozen.”

However, one potential way of skirting around the issue is to make a personal pension contribution, which could bring numerous financial benefits.

Ms Smith explained: “With careful tax planning individuals dragged above the thresholds could pay a personal pension contribution large enough to reduce their income to below £50,000 a year.

“By doing so, they could receive the triple benefit of less income tax, full child benefit payments and 40 percent tax relief on their pension contributions.

“Receiving the full child benefit could make a real difference to a family’s immediate financial wellbeing, while increasing pension contributions and benefiting from tax relief at their highest marginal rate will help them to save for later life.”

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