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Case study: Using pensions contributions to reduce adjusted net income

The problem:

The client has just started a family and currently has a young child. The change to child benefit coming into effect on 7 January 2013, means the client stands to lose the full £20.30 per week (£1,055.60 per annum) in child benefits for his child, as well £13.40 per week for each subsequent child that he may have in the future, as his current adjusted net income is £60,000.

The solution: To maintain child benefit payments the client could look to bring down his net adjusted income below the £50,000 threshold. This can be achieved effectively in a number of ways through financial planning.

One method is for the client to make a gross contribution of £10,000 into a registered pension scheme.

A £10,000 gross contribution would initially cost the client £8,000 due to the immediate 20 per cent tax relief – however, the end net cost would only be £6,000 as he would be entitled to claim a further 20 per cent through self-assessment.

Furthermore, if the client is able to sacrifice part of his salary or bonus to make the contribution, where the employer may include part of the National Insurance savings as a contribution, the tax efficiency will be increased further.

Alternatively, if the client is not in a position to make such a contribution into his pension but the client’s parents are in a fortunate position to have disposable income that is surplus to requirements then they could make the gross contribution of £10,000 into the client’s pension from their normal expenditure.

This would not only have the same effect of reducing the client’s net adjusted income by the necessary £10,000 but could also be extremely tax efficient for both parties.

It is extremely tax efficient for the client’s parents, as it helps to move money out what could be a 40 per cent death tax environment and into the client’s pension where it benefits from tax relief at the client’s personal rate.

To make a gross contribution of £10,000 into the client’s pension, the parents will need to remove £8,000 from their estate.

The pension contribution will benefit from a further 20 per cent tax relief as the client is a higher rate taxpayer and can reclaim the extra £2,000 via his self assessment.

The total pension contribution to £10,000, will reduce the client’s net adjusted income down to the required level to maintain child benefits.

So, the payment of £8,000 from the client’s parent results in £11,055.60 for the benefit of the client (pension contribution, plus tax relief, plus child benefit).

It also saves £4,000 in potential IHT for the client’s parents estate.

If the client’s parents do not have sufficient income to make the gift using the normal expenditure route, but happen to have capital at their disposal, they could use this capital to both make a £3,000 IHT exempt gift, which the client could use as above to pay into their pension and effectively achieve the same result (assuming the client could personally top-up the net pension contribution to £8,000 and then claim the higher rate relief).

With less than two months before the changes to child benefit come into force, swift action is required to preserve this benefit for affected clients and the solutions outlined above could provide an effective way to do so.

Phil Carroll is head of financial planning at Skandia

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Comments

There are 2 comments at the moment, we would love to hear your opinion too.

  1. There is an error in this article

    “the parents will reclaim the extra £2,000 via their self assessment.”

    No they won’t – the client does so in his/her own tax return.

  2. Didn’t know the parents could claim the extra 20% tax relief on making a contribution into their sons pension. I must’ve been away from financial advice school when that one was covered!!

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