The Fizz! Blog

Avoiding the Child Benefit trap, revisited

The advice for parents trying to avoid being drawn into the High Income Child Benefit Charge (HICBC) has been unchanged since 2013, as none of the thresholds ever changed. Since they have, at last, been increased, here’s an update on actions you might take to avoid or mitigate the charge.

If the higher earner in a household that has received Child Benefit has income of more than £60,000, they have to start giving the Child Benefit back to the government again, on a sliding scale, via their Self Assessment Tax Return. If they have income of more than £80,000, they have to give it all back.

If both parents earn £60,000, that's therefore fine - nothing to give back, even though total household income is £120,000. But if one earns £80,000 and the other zero (or a single parent has income of £80,000) then all of the Child Benefit has to be given back, despite household income being £40,000 lower!

If you've two children, HICBC could mean giving back £2,200 of Child Benefit to the government.

The most obvious way you could avoid or reduce the charge is with pension contributions. If your income is £70,000, then paying £10,000 into a pension reduces your income to £60,000 for these purposes, and you get to keep all the Child Benefit (as well as saving £4,000 of tax too - the way the tax reliefs work means that getting £10,000 into their pension ends up costing that person only £6,000). Of course, if you're struggling with household income to begin with, or earning way over £80,000, things may not be as easy as that and HICBC may be unavoidable. But if you can stand the short-term cashflow hit, for those around the fringes of the charge, pension contributions can become very compelling - and the more children you have, the greater the saving!

www.fizzhq.com

Your business probably isn’t going to pay for your retirement

It’s really common for business owners to believe that selling their business is going to be, or should be, what pays for their retirement. It’s very rare for that to really be the case.

First, most businesses are worth little or nothing. There’s nothing wrong with that! It’s just a fact of life. Your business may make a nice living for you, but that doesn’t mean that someone else is going to give you money to take it over - the revenue stream may be very much reliant upon your personal relationship with the customers, or it might just be a fair reward for the work and hours you put in. Some businesses are more or less jobs, and it’s unlikely anyone wants to buy your job.

Second, businesses that are worth something are rarely worth life-changing amounts. A typical rule of thumb is that a small business that generates steady profits that aren’t reliant on its owner and are above and beyond a normal commercial wage for them could be worth three or four years’ worth of profits. If you build up your business over 20 years, it’ll be nice to get a bonus of another three years’ worth of income at the end, for sure. What are you going to do in year four, though?  OK, if the income generated by your business is miles in excess of your domestic spending, the money you get from selling it might last much longer. But if you’ve got to a place where your business was generating a lot more money than you're spending personally, you’ll have plenty of money saved up anyway and won’t be so reliant on selling the business.

We often hear people expressing concern that they won’t be able to sell their business when they retire. Someone with a well-paid job doesn’t have anything to sell when they step away from it either, but should be able to plan for retirement regardless. As a business owner, you are not immune from having to save up like everyone else!

www.fizzhq.com

I’m moving abroad - is this going to affect me and my limited company?

20 or 25 years ago, international tax was something you studied a bit when training as an accountant, but in practical terms only those advising the very wealthy really had to engage with it. There was far less global mobility, relatively few freelancers moving to and from the UK, and digital nomads hadn’t been invented yet.

How things have changed! Now it’s really common for people - especially knowledge workers - to move in and out of the UK. International tax is no longer a theoretical subject!

So, it’s very common for us to have clients who arrive in, or leave, the UK. If you’re a sole trader or an employee, it’s probably fairly straightforward; mostly, people making “clean”, permanent moves are going to get something called “split year treatment”. That means that in the year of arrival only their income post-arrival goes on their tax return, and in the year of their departure only their income pre-departure. There can be some minor friction where they’ve moved to a country that considers them to have become resident there before or after they’ve ceased to be resident here, they may have other things going on (like property or investment income) that are more complex, and when moves aren’t so clean the deceptively complicated Statutory Residence Test comes into play, but most cases are pretty simple.

But if you have a limited company it’ll be messier. In our experience, it’s vanishingly rare for the continued use of a UK company to be a good idea post-departure. If you were a non-UK resident starting a new business, the circumstances under which a UK company would be the best vehicle would be somewhere between rare and non-existent. Leaving the UK whilst in possession of an LTD doesn’t change that underlying reality. Sometimes you might need to persist with your UK LTD for a bit (perhaps there’s an ongoing contract in progress that you need to finish), but in the end you’re going to want to set up whatever structure is most advisable in your new home.

Unfortunately, it can be quite difficult to execute this at the other end! It seems to be very common for someone to go to an accountant in France, for example, only to be told to just keep their head down and pay taxes as if they continue to reside in the UK. As UK taxpayers, we are quite happy for people to pay tax money into UK coffers rather than those of another country! However, as Chartered Accountants, that can put us in a difficult position; we can’t collaborate on a setup where we know that taxes aren’t being paid appropriately, or National Insurance credits being built up by someone who is not really entitled to them, or UK pension contributions being made in excess of the modest “run-off” amount available for a few years to someone leaving the UK, and so on.

It can be further complicated because often people won’t know their plans for sure. Someone who expects to be in Portugal for a year or two might not want to go to great efforts to set up a structure that they’re soon going to dismantle. But that’s always been the case; we’re quite likely to advise someone who comes to the UK with the intention of staying for a couple of years differently to someone who intends it as their forever home.

So, if you’re leaving the UK, please go and see an accountant in your new intended home as soon as you can! Your accountant here may be able to tolerate a period where you’re getting things set up at that end and continuing to run things at this end as you have been. But they won’t be able to tolerate it indefinitely.

www.fizzhq.com

On fiscal drag

Fiscal drag is the process by which a government can stealthily increase the tax they collect by leaving the thresholds and bands unchanged (or insufficiently changed) as incomes rise with inflation. If that happens for one or two low-inflation years, you’ll hardly notice it. But if it happens over a long period, or in a year of high inflation, you will notice. Unfortunately, both of those things are now the case! The important tax thresholds have been frozen for five years, and inflation is no longer trivial.

Five years ago, someone with a sufficiently profitable limited company might have looked with their accountant at the tax landscape, and their domestic income requirements, and decided to draw £50,000 a year from their company. They’d have known that they’d get a tax bill themselves of around £3,000, leaving them with effective net pay of £47,000 (or a little under £4,000 a month). That might have been fine to meet their requirements both for current spending and personal saving, and they’d stop there, given the sharp increase in tax rates if they paid themselves more.

Similarly, someone else might have figured out they’d draw £100,000, knowing they’d wind up paying tax of £20,000, leaving them with a net for the year of £80,000. Again, if that was enough to meet their aspirations they’d probably stick there - above that level of income you begin to lose your tax-free personal allowance, leading to some brutal tax rates between there and about £125,000.

If the bands don’t move for a year or so, it’s no big deal. If inflation is 2%, the things that used to cost you £47,000 now cost you £48,000. You might not even notice, and if you did notice you could manage it by just cutting down on treats, or rebalancing between saving and spending, allocating a bit more of your income to now, and a bit less to the future.

But if there are two years of 2% inflation, a couple of years of 4%, and then a year of 10%, you’ve got a problem. The things that used to cost £47,000 now cost £58,000! Maybe you can still cope by saving less, or saving nothing, or digging into savings. But even when all the treats are long gone most people will find that the maths doesn’t work and that they’re going to have to change something, and most likely pay themselves more and move into a higher tax bracket.

There’s more to it than tax, though.

Our £50,000 person has a couple of kids. If they can cap their income at £50,000 (and they don’t have a partner earning more), then the household gets to keep all its Child Benefit. But if their income goes above that level, they’ll have to start giving it back. Taking that and the increased dividend tax rate into account, the effective tax rate on the next £10,000 is nearly 55%! £5,500 for the government, £4,500 for the household (if they've got a Student Loan, then the effective rate will be even higher - 64%).

Leaving the bands unchanged for so long has really made a punishing difference, as more and more people are dragged into higher bands. If that Child Benefit threshold had risen with inflation over the years, the kind of employees who were originally deemed to not be earning quite enough to repay any of it would, obviously, still not be earning quite enough to repay any of it. Because the threshold has not changed at all, but their salary has, they’re having to repay all of it! The higher rate tax threshold has been frozen for five years - that Child Benefit threshold has been unchanged for 10.

Our £100,000 case could have even bigger problems. They gave up their right to Child Benefit long ago, but at least that “only” meant losing £2,000 in total in respect of their two kids. There are another two child-related issues though:

1. If someone in a household has income over £100,000, then the right to 30 hours a week free childcare for 3 and 4 year-olds is lost! That’s worth much more than £2,000.
2. And you also lose the right to a Tax-Free Childcare account, which could be worth up to £2,000 a year *per child*.

If one takes into account the value of the childcare hours, this person is actually going to find themselves with an effective tax rate way, way in excess of 100% on the first chunk of income over £100,000. This is not an obscure edge case; every year we’ll spot a couple of cases where people have to be careful not to jeopardise free and Tax-Free childcare by creeping over the £100k mark (you can sometimes recover the situation after the event with carried-back charitable donations, if you’re alive to it).

The issue doesn’t just affect people with their own company, making choices about personal income, of course. It applies to anybody managing a balance between consumption and saving, and trying their best to avoid cliff edges where entitlements are lost. Someone with a job could have been managing those issues by making pension contributions to keep their effective income below £50,000 or £100,000 - but the point will come where they no longer have enough money for the present day if they do that.

A government can really only employ fiscal drag as a tactic for a limited duration before things just don’t add up any more. For many people, things are not adding up any more.

www.fizzhq.com

Are you getting all the tax relief you can on your workplace pension contributions?

Automatic Enrolment pension schemes have been with us for more than 10 years now. They’ve been a success. They represented a change from “you can contribute some of your salary to a pension if you want to, but you’ve got to set it up yourself” to “some of your PAYE earnings will automatically be contributed to a pension unless you take positive action to come out of it, and then keep taking that action every few years if you want to stay out of it”. It was thought that many people might come out, but plenty would stay in. In fact, the vast majority stayed in. The government tops up your own contribution AND your employer has to contribute too - generally, people have to be very short on income in order to be willing to sacrifice the free money.

There’s a complicating factor, which is that there are two mechanisms by which the schemes can operate (and all employers pick one and one only - you don’t see them giving employees a choice). There’s no difference in how the employer contributions work, but there is a difference in the tax relief on the employee’s own contributions:

• Relief at Source (RAS). In these schemes, for every £8 you contribute, HMRC add another £2. That means everyone gets 20% tax relief from the outset - £10 in their pot at the cost of £8. If your income is above £50,270, and you’re therefore paying tax at a rate above 20%, you can save more tax, but you have to do a bit of extra work to get it.
• Net Pay Arrangement (NPA). In these schemes, your contribution is knocked off your salary before the tax on your payslip is worked out. That means that the tax relief you get depends upon your income:

1. If your income for the year is going to be less than £12,570 anyway, you’ll get no tax relief at all! The tax on your payslips was going to be zero, it’s still zero.
2. If your income for the year is going to be between £12,570 and £50,270, then the reduction in your gross means that you save 20% tax on the contribution. Just the same as your friend in an RAS scheme.
3. If your income for the year is going to be over £50,270, then you’ll save tax via the tax deduction on your payslip at a higher rate - the exact rate depends on your income. The best case scenario is if your income would otherwise be between £100,000 and £125,140 - the reduction in your gross means that you save 60% tax on the contribution! You don’t need to do anything to get all the tax relief you’re due, it all happens on your payslip.

There’s one type of person who loses out permanently here. It’s NPA person #1. They get no tax relief at all! The lowest income people, if they’re in an NPA scheme, get the least government contribution to their pot. An employer who is likely to employ a bunch of people like this might lean towards an RAS scheme if they were kind.

A person who has income between £12,570 and £50,270 should be indifferent to which mechanism is in use. They save 20% either way.

A person who has income above £50,270 should be more or less indifferent between the mechanisms as they needn’t miss out anything - but if they’re in an RAS scheme they just have to put a little more effort in. If they have to do a tax return anyway, the work is minimal - keeping track of their contributions for a tax year and sticking the number in a box on the return. If they don’t have to do a tax return, it’s still not that much work. They don’t have to join the tax return system - they can just write to HMRC once a year to tell them about their contributions, or tell HMRC via their Personal Tax Account. HMRC will just get the employer to adjust their monthly PAYE deductions to get to the right overall result.

In reality, there are likely to be tens of thousands of people who should be doing this, but aren’t. If you’re a higher-rate taxpayer and you don’t know what kind of scheme you’re in, it’d be a good idea to find out! The most commonly used provider, NEST, is a RAS scheme - 20% relief at the time, but you’ve got to do the work yourself to get any further relief you’re due. The second most commonly used provider, The People’s Pension, offers employers a choice of either option at the setup stage, so it could be either! You’d be able to find out from your employer, or from your online account - or from an accountant or PAYE professional looking at your payslips! And if you’re actually in a salary sacrifice system - which is probably the third most common way of dealing with all this - then that’s effectively an NPA, so you’re getting all your relief up-front.

www.fizzhq.com

Going on maternity leave? Think twice about opting out of your employer’s pension scheme

When someone's about to go on maternity leave, they'll quite often look at trying to temporarily cut all unnecessary overheads.  You might think that one sensible step would be to opt out of their employer's pension scheme for a while.  Cutting this particular overhead is probably a very bad idea though.

If your employer operates their Automatic Enrolment pension scheme on the most common basis, you’ll be making a contribution each month, and so will they.  Those contributions vary according to your income, and get capped if you’re earning more than £50,000 per annum.

If you go on maternity, your income drops, and so do your contributions.  In fact, after the first six weeks of leave, from which point your salary will probably just consist of basic Statutory Maternity Pay, they’re likely to drop to zero.

But, crucially, your employer’s contributions do NOT reduce at all.  They’re obliged to carry on paying into your pension pot at the level mandated by your normal salary!  Other non-salary benefits work on the same basis, too; they can’t take away your company car or withdraw your medical insurance, for example.

So, by opting out at the start of maternity, an employee could lose nine months of employer pension contributions, whilst saving herself virtually nothing.  A very easy trap to fall into!

www.fizzhq.com

Can I make pension contributions for family members through my limited company?

The rules on how much money can go into someone’s personal pension in a tax year aren’t intrinsically complicated - there are just lots of them. Broadly:

• Almost anyone (even an infant) can have up to £3,600 go into a pension scheme or schemes in a tax year.
• The cap each tax year (the Annual Allowance) on what can go in is £40,000.
• However, unused Annual Allowance from the prior three years can be used too (if you had a pension pot of some sort in place at the time).
• Personal contributions in any year are capped at earned income.
• Employer contributions aren’t capped in that way (so a director with a small salary isn’t limited to contributions equivalent to that salary - their company can contribute more).
• Annual Allowance may be reduced for those with income over £200,000.
• The Lifetime Allowance may prohibit or penalise contributions for those with very big pension pots.

All simple individually, but the synthesis of them can be complex!

There’s another consideration involved where contributions are being made via one’s own limited company. For the company to get tax relief on the contributions, the same standard must be met as for any other overhead - is the cost incurred wholly and exclusively for the purpose of the company’s trade? In practice, that means - does the bundle of PAYE salary, pension contributions and other benefits that the director is receiving represent a reasonable bargain for the work being done, or is it excessive?

For a typical fee-earner, generating the company’s income, it’s almost certainly going to be fine. If your company is making enough money to sustain £12,000 of salary plus £40,000 of pension contributions a year, a £52,000 “package” is unlikely to be excessive and there should be no trouble with the company getting tax relief.

A fairly common question from people already doing that is - can I do the same for my spouse or partner too? That’s much more problematic. If they’re doing no work for the company, then a package of £1 would be excessive, let alone any greater amount! If they’re doing some work, you’ll have to take a position on whether the proposed contribution would meet that “wholly and exclusively” test, when considered alongside any PAYE salary also being paid.

In practice, this tends to mean that for fee-earners, big contributions are fine, whereas for a spouse doing some admin support, say, material contributions aren’t really defensible (and there would instead be an argument for their being taxable as income on the director instead!). It’s easy to get confused about the mechanical “how much can go into the pot” rules, and overlook that aspect.

www.fizzhq.com

Should I make pension contributions personally or via my limited company?

Generally, via your limited company.  An exaggerated example explains why.

Imagine it’s the evening of the last day of your company year, and you’re so keen to get your year-end accounts done that they’ve been drafted already.  You can see you’ve got £10,000 of profits.  You’d like to get that into your pension pot.  There are two ways you could achieve that.

The first is for your company to make an employer contribution directly to your pension fund of £10,000.  That reduces the company profits and tax bill to zero (if you do it before midnight, anyway!), and gets £10,000 into your pension pot at a cost of £10,000.

The second is to take a dividend and make the pension contribution yourself.  If you decide to do that, you know that the company will have £1,900 of corporation tax to pay on its £10,000 of profits, so you take the maximum legally permitted dividend of £8,100, once more leaving the cupboard bare.  You contribute that £8,100 to your pension personally.  There’s basic rate tax relief on it, which means that the government gives the pension company another £2,025.  You’ve got £10,125 in your pension fund - that’s better, right?  It is until you do your tax return and have to pay tax on the dividend.  Assuming it sits in your basic rate tax band you’ll pay £700 of tax on it, so actually it’s cost about £10,700 to get that £10,125 into your pension pot (and there’s a similar marginal cost if the dividend is taxed at higher rates too, as higher dividend tax and greater tax relief cancel each other out).

One small caveat.  If you’re thinking of applying for a mortgage or a remortgage, you might choose to take higher dividends and make personal contributions, even though you’ll wind up a bit poorer that way.  That’s because it will maximise your personal taxable income, and that’s what a lender looks at when deciding how much to lend to you. But if you’re looking for the biggest pension pot at the lowest cost, company contributions are the way to go.

www.fizzhq.com

What’s the pension annual allowance?

“How much can I put into my pension this year?” sounds like quite a simple question, doesn’t it? Often, though, our job is to point out that a question that quite reasonably seems straightforward is not. This is often one of them!

One of the overarching concepts with pensions is the Annual Allowance. This is generally thought of as “how much can I contribute to my pension each year?”. But it’s not as simple as that. A better way of thinking of it is “what’s the most money that is allowed to make its way into my pension pot this year?”. Because personally contributing isn’t the only way money can get into your pension. There are really three:

1. You can make a contribution personally into your own pension scheme (by, for example, contributing to a personal pension or an Automatic Enrolment one - a Defined Contribution scheme, where there's a visible pot that's yours; the vast majority of pensions these days).
2. Your employer (which might be your own limited company) can similarly make a contribution into a scheme.
3. If you’re in a Defined Benefit scheme, where there’s no discrete personal pot of savings but your employer promises to pay you a pension once you retire, from their pension fund as a whole, then your employer can increase the pension it promises to pay (this happens a lot with NHS consultants, whose promised pension increases each year with longevity and seniority). That’s deemed to be an increase of a notional pension pot, counting towards the Annual Allowance and the employer must quantify it for you.

Fundamentally, we all have an Annual Allowance of £40,000, and that's the total cap on those three things put together. But there are still complications:

• The Annual Allowance is reduced if your income for the year is over £240,000 (previously £150,000).
• If you’ve not used up all your Annual Allowance in the previous three years, that’s usually added to this year’s allowance too. So, in an extreme case someone could have £160,000 legitimately make its way into their pension funds this year.

We’re not done, though. The Annual Allowance is simply a ceiling on what can go in by one route or another. But there are separate limits on what can go into personal pension funds via those first two routes:

• Although anyone can contribute up to £3,600 to a personal pension in a tax year, above that the amount you can contribute personally is capped at your “Relevant Earnings” - basically, your income from a PAYE job or an unincorporated business. So even if someone has Annual Allowance of £88,000 available because they’ve got some unused AA from earlier years, if their income for this year is £42,000 via PAYE then the maximum personal contribution they can make is £42,000 (even if they’ve loads of spare cash beyond that). Directors on a small salary therefore can't pay much into their pension personally. (It’s also important to remember that personal pension contributions are made net of basic rate tax, so if that person wants to contribute £42,000, they’ll actually hand over £33,600 to the pension company, who’ll get the other £8,400 from the government).
• The amount your employer can pay into your pension needs to be justifiable in terms of the total “package” you get from them (otherwise it’s not a legitimate deduction against tax for them). If your employer is just a third party, that’s going to be the case automatically; the whole reason they’re giving you that salary, pension contribution etc is because they think it’s an appropriate economic bargain for your services. When it’s your own company it needs more thought. If you work through your own company, is it reasonable for your company to put £40,000 into your pension? Generally, yes. It’s likely that, in conjunction with the small salary you’re getting, the total package wouldn’t be considered excessive, as you seem to be generating enough value for the company that it can afford the package. So this is how most director-shareholders fund their pension; their contributions aren’t capped at their small salary, because they’re not making personal contributions. Would it be reasonable for the company to make a similar payment into the pension of a non-working spouse? No. If they’re not working for the company, the appropriate employment package for them would be zero.

It’s even harder if you’re in a defined benefit scheme - you won’t know about the deemed increase in your pot until after the year-end, at which point it’s too late to make any further contributions for the year! The uplift might be less than you thought, and you’d have liked to have put another £5,000 into another personal pension you have - unlucky! The unused Annual Allowance will have been carried forward to use in the next year, though (if income and so on permits).  Or the uplift might be more than you thought, taking you over the Annual Allowance you have available - in which case you've tax to pay.

Pensions are pretty simple for many, but not for everyone!

www.fizzhq.com

When might directors pause their employer pension contributions?

Imagine your company has a 31 March year-end.

Are you going to make an employer pension contribution in March 2023?  Probably not.  If you make the contribution in March 2023, it’s going to save corporation tax at 19%.  If you wait one month (one day, even) until April 2023, it’ll save corporation tax at the new rate of 25% (albeit 12 months later, but it’s still a guaranteed 6% return).

Are you going to cancel a planned contribution this month, and wait until April 2023 and the greater tax saving?  Probably not - on average, 25 months of tax-free investment growth would be likely to outstrip the 6% tax difference.

Are you going to make an employer pension contribution in February 2023?  Probably not. If you wait two months until April 2023, it’ll save corporation tax at the new rate of 25% rather than 19%.

Are you going to cancel a planned contribution next month, and wait until April 2023 and the greater tax saving?  Probably not, it’s fair to think that 24 months of tax-free investment growth will still have a fair chance of outweighing the 6% tax difference.

There’s a point somewhere in between where might choose to pause contributions, though.  Over the long term, the profits in your company above and beyond what you pay yourself are going to be split in some fashion between pension contributions and building up reserves in the company.  Mathematically, you'd ideally do the former when the corporation tax rate is 25% and the latter when it’s 19%.

Of course, this interesting dilemma presupposes that there will be no changes to the other rules and limits on pension contributions between now and 2023-24.  Historically, that's often been a reckless assumption!

www.fizzhq.com