Contractors: act now to avoid child benefit cut
Perhaps one of Chancellor George Osborne’s most contentious plans to date is his claw back of child benefit from higher earners. Contractors earning over £50,000 a year need to act now to ensure that they won’t be caught out. The following strategies, from freelancer specialist IFA Tony Harris of ContractorMoney, are designed to ensure that you keep this all important benefit.
For better or worse...
HM Revenue & Customs will deduct 10% of your child benefit for every £100 that you earn over £50,000p/a, effectively removing your entitlement altogether if you earn over £60,000. The claw back scheme looks at individual income to ascertain whether your family is entitled to claim child benefit and this means that if your partner is a full-time parent receiving child benefit - but you earn total salary or dividends over a total of £50,000 - then the claw back will still apply.
HMRC will not take personal circumstances into consideration so whether you are cohabiting; married, separated or anything else in between, this rule affects everyone that is attached to the child in question. This could therefore lead to higher earners being penalised even if they have no direct access to the benefits received.
Even more controversially, the fact that a couple each earning £49,000 could have a household income of £98,000, but still be entitled to receive 100% of their child benefit, means that they could earn far in excess of the £60k earned by a sole breadwinner who was losing his or her benefits altogether.
Any amount owed under the child benefit announcement will be clawed back via your self-assessment tax return, so those contractors who are affected have two options.
Cancel or collect?
Either you can cancel your child benefit claims from January 2013 onwards, or alternatively you can continue to collect child benefit and then pay back whatever is owed upon self assessment. For contractors obviously earning over £60,000, it makes sense to cancel the benefit claim as the amount you repay will equal the amount you receive. However, if you earn between £50k and £60k then you may choose the self-assessment route.
Either way, there are a number of things you can do to reduce your claw back:
For richer or poorer...
If you are the only breadwinner or your partner earns significantly less than you, then dividing your income producing assets could help to lower your individual earnings while ensuring that the overall family income doesn’t fall.
Split dividends via your limited company will already have this affect but paying your partner for work done to help run your limited company; ideally up to the threshold for NI, may significantly help towards keeping your child benefit entitlement.
If you have other assets such as savings, investments or buy-to-let property then transferring these solely into the name of the partner that is earning less could also help to even things out and reduce your personal income to below the £50k threshold.
In sickness and in health...
If you are contracting through a one-person limited company then you could lower your taxable income and still protect your loved ones by paying for life insurance through your company. A new ‘Relevant Life’ Keyman insurance is now available for contractors which offers the same benefits as a large employer ‘death in service’ policy. The great news for your child benefit claim is that the policy is paid directly from the company rather than from your net income, so the dividends or salary you need to draw can be reduced which may help you perfectly legitimately avoid the £50,000 threshold.
Irrespective of this new child benefit cap, if you are currently paying for a life cover policy out of your own pocket then it always did make sense to look instead to a Keyman policy, but this new tax rule makes addressing this opportunity much more urgent.
If you are teetering on this £50,000 limit then a Keyman policy could make all the difference when calculating your claw back. You also benefit from the peace of mind that you have a comprehensive life cover policy in place if the worst should happen.
Till death do us part...
If you are contracting via an umbrella company then they should have a decent in-house pension in place for you to use for child allowance purposes. This ‘employer’ pension enables you to exploit what is known as ‘salary exchange,’ to transfer part of your invoices to a retirement plan and therefore reduce your taxable income. Although you won’t have access to your sacrificed income immediately, you will be building a nest egg for the future and in nearly all cases will also be avoiding both Employers’ and Employees’ National Insurance on your invoice.
Jim currently takes a salary of £60,000 a year and invests £10,000 via salary exchange, and so has successfully reduced his benefits claw back completely. Not only will Jim, a father-of-three, have avoided income tax, employees’ and employers’ NI at approx 50%, but he will also have secured the £2,500 child benefit and have £10,000 invested for a life after contracting. This £10,000 pension pot has effectively ‘cost’ only £2,500 in net income and when Jim retires he also has the ability to draw 25% of the fund as tax-free cash too, leaving the balance to pay an income for life.
Similarly, a limited company can also be used to fund your pension rather than simply have funds build up in the corporate bank account to earn what are currently pretty woeful rates of return. Especially where the child benefit cap is concerned, this must represent a far more tax-efficient way to transfer money from contract to personal hands than salary or dividend.
So while George Osborne’s latest tax raising wheeze may seem like yet another attack on middle earners, at least contractors have a degree of flexibility in terms of how they draw their income and therefore have scope to structure their affairs to avoid the worst of the child benefit claw back. Time to act, however, is not on your side.