Like 500,000 other households this week I received a letter from my favorite government department HMRC.  The letter explained that I need to decide whether to stop child benefit altogether or be happy to pay extra tax.

I am afraid to admit that I don’t really pay too much attention child benefit in our household.  The money comes into an account set up by my wife for our daughter.  Out of this my wife then pays for all the clubs, sports and school trips etc.  I certainly don’t see any change from it!!

On reading the letter I suddenly realised that it would be me paying the extra tax if I qualified under HMRC’s new earning definition.  All of a sudden Child Benefit caught my interest!!  After all who likes paying tax on money they never see!!

My first instinct was just to cancel the child benefit, as it would be too much hassle for such a small amount.  When I realised we actually received £1,050 pa (that would pay my golf club subscription!!) I thought I better look into it a bit further.

Here’s what I found:

The Income Test

The new rules say that if one member of the household earns over £50,000 pa then the new tax will apply progressively until all the child benefit is repaid by through tax.

If tax is due then the highest earner in the household (i.e me) pays the tax via their tax return (I’ll come back to the tax return).

Included in the income test is the following:

• salary (before any pension contributions are taken away)
• company benefits you get (eg car, fuel and medical benefits
• profits if you’re self-employed
• interest you get from savings (including any tax that’s already been paid on it)
• State Pension payments and other State benefits that are taxed
• payments from personal and occupational pensions or annuities
• income from dividends (including the dividend tax credit) or trusts
• rental income

Looking down the list I thought WOW!! Respect to anyone who is State Pension age and still claiming Child Benefit!!

The good news is you can deduct a few items from your income:

• interest you get from tax-free savings
• any pension contributions you have made
• self-employed trading losses
• any gift aid donations

The resulting figure will give you the amount you need to test against the £50,000 limit.

So why would you cancel child benefit what was the worse case scenario?  After doing a bit of digging around I found a rather handy calculator on the HMRC website to help out further.

https://www.gov.uk/child-benefit-tax-calculator

This calculator allows you to calculate the amount of tax you would pay over the course of a year.  Be careful with this calculator; if you input your figures using the 2012-13 year the new rules only apply from January 2012 or three months of the current year.

For a more realistic view I would recommend you choose the 2013-14 tax year and you will be able to see the full effect of the changes over a full year.

To Stop Child Benefit or to Pay the Tax?

Once you have the results from the calculator you will need to make a decision whether to stop your child benefit or pay the tax.

If there is no benefit to you, it is possible to receive £1,050 pa in child benefit and have to pay back £1,050 pa in tax; there is little advantage to continuing with Child Benefit payments.

If you still receive some benefit from your Child Benefit, after taking the tax into consideration, it will be up to you to decide.  One thing you need to consider is the need to complete a tax return to pay the right amount of tax.

First Time Tax Returns

If you have always been employed, it may be the first time you have completed a tax return.  This can be very time consuming to do it yourself or costly if you decide to employ an accountant.

I believe if the resulting benefit is small it may be better to opt out of Child Benefit and avoid the hassle of completing a tax return.

Little Johnny – Can you pay my tax please?

Thinking this through, I just imagined lines of parents queuing up at building societies around the country on the 31st January, withdrawing their children’s savings, so that they can pay their unexpected tax bills due to Child Benefit.

Is there anything you can do?

If you find yourself with income between £50,000 and £60,000 there are number of things you can do reduce your income for the Child Benefit income test:

• Making a Pension Contribution.
• Making Gift Aid qualifying donations.
• Make sure your savings are arranged in a tax efficient manner.

All these will all help bring down your income for the Child Benefit calculation.

Back to the real world . . .

May I suggest if your children guard their building society books the way my daughter does, there is little or no chance of getting the tax back from them!!!

My advice is therefore to check out the HMRC calculator and make sure you act before the 1^st January 2013.

If in doubt you should seek advice from a Chartered Financial Planner.