How to keep your Child Benefit

by Cliff D'Arcy on 29 October 2012  |  72 comments
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Using these three tricks, top taxpayers can keep the tax-free Child Benefit payment after April 2013!

This week around one million households will receive letters from HM Revenue & Customs about possibly losing Child Benefit.

From 7th January 2013 Child Benefit will be adapted so that households where one adult's income is more than £50,000 in a tax year will face a Child Benefit Charge. For those earning above £60,000, the tax charge is 100% of the amount of Child Benefit. For those earning between £50,000 and £60,000, the charge is 1% of the Child Benefit paid for every £100 of income earned between £50,000 and £60,000.

Here are the current rates of Child Benefit, which have been frozen until April 2014:

Three ways to beat the system

Here are three ways that top taxpayers can legally beat the system and retain this tax-free support for their families in future:

1. Pump up your pension

The simplest way to avoid losing your Child Benefit is to avoid earning more than £50,000 in the first place.

Anyone who can get their income just £1 below whatever that threshold will keep all of their Child Benefit, which could be worth thousands of pounds a year, free of tax.

The easiest way to sneak below the threshold is to pay more into your pension. For example, paying an extra £2,000 a year into a pension could cut your take-home pay by just £1,200, thanks to 40% tax relief on this contribution if you're a higher-rate taxpayer.

What's more, if this additional pension contribution safeguards your Child Benefit, then it could mean thousands of pounds a year in extra income. One other way of achieving this would be to sacrifice part of your salary, in return for higher yearly pension contributions from your employer.

2. Collect childcare vouchers

Alas, since last April, this allowance has been cut to £28 a week for 40% taxpayers and £22 a week for 50% taxpayers (those earning over £150,000 a year). The good news is that existing members of childcare schemes still get the previous tax-free allowance in place before April 2011. So this change affects only new joiners since 6th April 2011.

Grabbing your full allowance of childcare vouchers could drop your pay below the £50,000 threshold.

3. Become a company

My third -- and most radical -- solution to this Child Benefit problem is to start your own private limited company. This can be a highly tax-efficient way to earn a good income while paying minimal amounts of tax.

For example, you could decide to pay yourself a minimal wage (below the thresholds for income tax and National Insurance), all of which would be tax-free. Then, instead of paying yourself any more in salary, you declare and pocket dividends from your company shareholding.

As long as your total income doesn't exceed the £50,000 threshold, then no extra tax is due on these dividends. However, your company will have to pay corporation tax at the 'small profits' rate of 20% on these dividends.

What's more, any dividends above this level attract higher-rate tax at 32.5%, less a notional tax credit of 10%. In effect, this translates to an effective tax rate of 22.5% of the declared dividend or a quarter (25%) of the net dividend in your hand.

Then again, incorporating as a company isn't an option for most employees, as an anti-avoidance rule known as IR35 requires that you prove you are not simply "an employee at arm's length."

In addition, there is a great deal of paperwork required to be a company director, so you may need to pay an accountant to administer your payroll and tax affairs. Even so, this is a very attractive tax route for high-earning consultants, the self-employed and freelancers like me!

This is a lovemoney.com classic article that has been updated

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