Kelly is employed and, as she lives in England, she is subject to a higher rate income tax threshold of £50,000 from 2019/20.
She is the highest earner in her family. Her adjusted net income (ANI) after her contributions to her employer’s pension scheme is exactly £49,600. Kelly has been told she will get a 5% pay rise effective from 6 April 2019. This will take her ANI up to £52,080 for 2019/20.
She has two children and receives £1,788.80 a year in child benefit. So after tax, national insurance (NI) and the child benefit being paid, she will have £38,572.68 net. She has accumulated savings (above her emergency fund) of £2,600 and is keen to mitigate her higher-rate tax liability. She does not expect to be able to build up the same level of savings in the next tax year.
Kelly has made pension contributions in the past and is aware that, after tax relief is applied to her savings, the gross contribution of £3,250 would eliminate all of her higher-rate tax liability this year.
Individuals lose child benefit through the high income child benefit charge (Hicbc) for ANI above £50,000. You lose 1% of the child benefit for every £100 you are over. Given the known pay rise, Kelly will have an ANI of £52,080 next year, meaning a Hicbc of £358.
This means next year Kelly will move from being a higher-rate taxpayer to paying effective tax of 57.16% on the portion of her income over £50,000, which is the higher rate threshold next year also. Working through the numbers, she has £2,080 over £50,000, so the tax on that at 40% is £832. Adding the Hicbc, this means £1,189 will be due to HM Revenue & Customs next year. £1,189 is 57.16% of the £2,080 that is over £50,000.
Kelly meets her adviser and is confused when he says she would be better off not contributing £3,250. Instead he recommends making a pension contribution this year of only £936 net (£1,170 gross) and making a further contribution of £1,664 net (£2,080 gross) next tax year.
The two differing scenarios are detailed in the chart below. Over the two tax years, the same amount goes into a pension. Kelly will have £3,250 in a pension pot, and there may be investment fluctuations that would affect her return if she waits until 2019/20 to invest the remainder.
But from a pure taxation point of view, delaying the pension contribution and avoiding the Hicbc next year makes Kelly £358 richer in total. Kelly will benefit from an effective rate of tax relief of 57.16% next year.
The movement of the higher rate threshold to £50,000 was a pleasing outcome for English taxpayers in the 2018 Budget. But it also means the effective rate of taxation for those receiving child benefits earning above £50,000 may be a lot higher than 40%.
Given this, maybe it is not just tax year-end planning that is required, but also tax year-start planning for next year too?
Mark Devlin is senior technical manager at Prudential