In the UK, everyone is taxed as an individual, but social security benefits, including tax credits and Universal Credit, are awarded on the basis of the family’s total income. Child Benefit is clawed back based on the income of the higher earner in a couple, irrespective of who receives it.
Families with an unequal distribution of income will often pay more tax than couples who each earn just enough to cover their personal allowance (PA) and the basic rate band. The thresholds for restricting Child Benefit (£50,000), PA (£100,000) and pension annual allowance (£240,000) all operate for the individual, so disadvantage families where the income is concentrated in one person’s hands.
Consider the Browns – they have two children and claim Child Benefit. In 2022/23 George Brown earns £90,000 and pays higher rate tax, but Sally Brown has no income. As George’s income is over £60,000, the family’s total Child Benefit is clawed back from him as a tax charge.
In contrast, John and Joy Green each earn £45,000, so they keep their Child Benefit and pay less Income Tax, as their highest marginal tax rate is 20%. Both Greens make use of their full PA and most of their basic rate band.
Roger and Rose White are in a worse tax position. Rose’s total income is £210,000 and her employer contributes £40,000 into her pension scheme every year. Roger and Rose have no effective PA, as Roger has no income to set his allowance against and Rose’s PA is entirely withdrawn, because her income exceeds £125,140.
Rose is treated as having income of £250,000 (£210,000 + 40,000) for pension relief purposes. Her pension annual allowance is therefore reduced to £35,000, so she suffers an annual allowance charge at 45% on £5,000 of the pension contribution made by her employer.
These examples show that families can save tax if they transfer some income from the higher earner to the lower earner, in order to take advantage of the PA or lower tax bands and to avoid the reduction of PA or the clawback of Child Benefit. This is not always easy to do, but the following methods are permissible:
- make an outright gift of investments that produce taxable income
- put savings and investments into joint names and share the income
- employ the spouse or partner in the other person’s business
- take the spouse or partner into partnership in that business
HMRC can challenge some of these methods if they think the transfer is not genuine – always take tax advice to be sure that your plan will work.