Families who increase their pension contributions will lower their income for purposes of the high income child benefit charge, and will face a smaller charge as a result, Royal London analysis has shown.
Thousands of working families are failing to take advantage of a link between their pension contributions and their child benefit entitlement, causing them to lose up to £171m per year.
Since 2013, working families where one parent earns more than £50,000 face a special tax charge on child benefits.
The high income child benefit charge is worked out as 1 per cent of their child benefit for every £100 earned above the £50,000 threshold, up to a maximum of 100 per cent.
Where someone in the family earns more than £60,000 the tax charge is equal to the amount they get in child benefit.
However, HMRC measures earnings for these purposes on the basis of income net of pension contributions.
Which means, according to Royal London, that those in the earnings band of £50,000 to £60,000 who increase their pension contributions can face a smaller tax charge on their child benefits.
Sir Steve Webb, director of policy at Royal London, said: “For a higher earning family, putting money into a pension is already a very attractive option. They benefit from higher rate tax relief on their contributions and may also get a matching contribution from their employer.”
But what these families “may not be aware of is the additional advantage of reducing the tax charge they face as a higher income family receiving child benefit,” Sir Steve said.
“This is another reason for families in this income bracket to prioritise pension saving and to take advice about their options,” he added.
In 2013, the Institute for Fiscal Studies estimated that around 320,000 families would fall within the £50,000 to £60,000 earnings band.
If each of these people were to contribute an additional £3,000 per year into their pension, they would reduce their charge by 30 per cent of the amount of child benefit received.
For a family with two children this would be a gain of around £536 per year.
Across all families in this income bracket, this could be a saving of £171m per year, Royal London said.
Number of children
Saving in high income
Alan Chan, director and chartered financial planner at London-based IFS Wealth & Pensions, said he has given this advice to some of his clients.
He said: “Pension contributions represent really good value for money in this [earnings] bracket because not only do they get the higher rate of 40 per cent tax relief, but [they] also eliminate the special tax charge.”
Mr Chan also said that it is the gross pension contribution that counts.
He said: “A gross contribution of £500 each month is just £300 net for a higher rate tax payer, and this would have the effect of reducing their ‘adjusted net income’” by £6,000 in a year, and they may qualify for child benefit again without any deductions.”
The fact that the tax is applied after the child benefit is paid to the families might mean that “many people may not necessarily realise they are not actually getting anything at all,” he added.