| Real Life Strategies for Building Wealth

Pounds (copyright TaxFix.co.uk)
One Saturday a few months ago we were out shopping in the village and bumped into a good friend of ours who has four children – we know quite a few such families.  The brief conversation got round to the (then) imminent withdrawl of Child Benefit from the ‘better off’ from Jan 7th 2013, the result of George Osborne’s 2012 budget.

Child Benefit is a payment made on behalf of the child generally to the mother.  It is £20.30 for the first child and £13.40 for each additional child and is tax-free.  If either parent earns over £50k a year, it is withdrawn at 1% per £100 excess so that by £60k it is all gone.  But because a variable amount of money (depending on the number of children) is withdrawn over a fixed interval, the marginal tax rate will depend on the number of children you have (which may be adopted or fostered).

We pointed out the iniquity of a potential 73.5% marginal tax rate where you have four children and that, above 8 children, people will suffer over 100% marginal rates – you end up losing more money than any increase in pay, which, as policies go, is seriously stupid.   We were pleased to see a similar realisation eventually hit the Institute for Fiscal Studies, although this was largely mis-reported by the media who hadn’t realised that the marginal tax rate increased according to the number of children concerned and that some – albeit a few – will be taxed at over 100%.

The original idea had been to withdraw the benefit when one of the parents started to pay higher rate tax – at about £40k.  Many pointed out that this was a very unfair cliff edge – and infinte marginal tax rate – and eventually Osborne relented and moved the limit to withdrawing benefit on a sliding scale between £50k and £60k.

But, as our friend pointed out, the £50k limit applies after pension contributions.   I had missed this completely and was back to the online tax calculator when we got home to see how this affected us.

Phew – we just escaped.

So then we got to thinking, giving the then also imminent paying off of our negative wealth which showed that we can live on a lower income, would it not be appropriate once we started investing to increase Maria’s pension payments?  That would ensure (a) that we avoided future withdrawl of Child Benefit yet (b) that ultimately she would draw this as pension anyway, by which time the reason for the Child Benefit will be, we hope, at university.

We are working on this now and looking for a suitable Self Investment Personal Pension or SIPP, which is the UK equivalent of an IRA in the US.  If we can invest in a SIPP, we can treat it just as part of our investment portfolio.

The rules for pension contribution in the UK are that you make the payment and the government tops it up.:-)  The maximum allowed per year was reduced in last year’s budget from £50k to £40k (for 2013/14) so this means that if you are on up to £90k and can afford it, you can effectively commit up to £40k to a pension and still retain your Child Benefit.  And if you earn up to £100k, there is still some point in doing this although there will be a tax charge.  If you have already declined your Child Benefit, you can always change your mind – at least it says so on the HMRC website.

Here is what you can do if your total pre-tax salary is up to £100k a year.  It is unlikely now that you will be able to get your payroll to do this on a once-off basis so it is better done via a SIPP:

  1. Calculate how much pension headroom you have – this will be £40k minus your present gross pension contributions.
  2. Calculate your total pre-tax income less £50k.
  3. Multiply the lower of these two figures by 0.6 – the balance of the 40% tax rate.
  4. Pay this amount into the SIPP.  The government will gross this up at basic rate of 20% (ie the government will add a further 20% to your contribution) and you are credited with the rest in your self assessment form so you can reclaim it as cash, which you can invest back in the SIPP if you want.
  5. If both parents are in this earning bracket, both need to do this or the Child Benefit will be withdrawn according to the higher earner anyway.
  6. You do not have to commit to this forever.  As your salary changes, you can vary the amount or even stop it if you want.

For example, adding £1000 into a SIPP from your taxed income, equivalent to £1666.66 untaxed, the government will add £333.33 and you can reclaim the same amount at the end of the year.  So your net contribution will be £666.67 and your pension fund will have grown by £1333.33.  The Child Benefit withdrawl will be 16.6% so it becomes directly worth while if you have 5 or more children.  Even with two children, your pension fund will grow by 3.6 times the cost and for 4 children by 9.4 times!

We are not tax specialists so please check your individual situation first with a qualified expert.

Hurry to do this before the tax year ends on 5th April, and save your Child Benefit!

So you have a double whammy – first you still get your Child Benefit and second you build more pension  to which the government contributes!  OK so you can’t draw that out until you are 55 (when you can draw 25% free of tax) but it will still be there and growing.

There will be some transitional arrangements for the first year as the new rule only came into force on January 7th, roughly ¾ of a tax year, because the withdrawl is on an annual basis but George doesn’t seem to have thought about that.

You see, tax avoidance is not so difficult after all and many of us can do it.  Until of course the rules change again.  Nice one, George.

Meanwhile The Money Principle has defined a new unit.  No, it is nothing to do with Higgs fields or physics.  It is the UBS – the Unit of Budget Stupidity.  For the moment, it has a short name – the Osborne or the ‘O’.  We will now grade all tax and budget pronouncements in O’s.  – we won’t bother with the mundane.

The Child Benefit scandal we award 0.8O’s – I am sure Bullingdon George will do something even more stupid if he hasn’t already so we have to leave a little room for this.  And, as we pointed out before, the announcement prompted us to check and we got a rebate of some £2.5k as Child Benefit for our son which had been underpaid for nine years so we can’t really award anything bigger.

Suggestions are welcome for the O-table…!  The best idea will be rewarded with a small donation to a charity of your choice.