Tax Strategies for Families with Unequal Income Distribution

In UK, individuals are taxed separately, while social security benefits such as tax credits and Universal Credit depend on a family’s total income. Child Benefit clawbacks are determined by the higher earner’s income within a couple, regardless of the actual recipient. Consequently, families with an unequal income distribution typically pay more tax than couples whose earnings cover their personal allowance (PA) and the basic rate band. Thresholds for restricting Child Benefit (£50,000), PA (£100,000), and annual pension allowance (£240,000) disadvantaged families with one primary earner.

Consider the Smiths, a family with two children who claim Child Benefit. In the 2022/23 tax year, Adam Smith earns £90,000 and pays a higher tax rate, while Eve Smith has no income. Adam’s income exceeds £60,000, leading to a complete clawback of the family’s Child Benefit as a tax charge. In contrast, Jack and Jill Green earn £45,000, allowing them to keep their Child Benefit and pay less Income Tax at a maximum marginal rate of 20%. Both Greens fully utilize their PA and most of their basic rate band.

Tom and Tina White face a more unfavourable tax situation. Tina earns £210,000, and her employer contributes £40,000 annually to her pension scheme. Tom has no income to offset his PA, while Tina’s PA is entirely withdrawn because her income surpasses £125,140. Tina’s income considered £250,000 (£210,000 + £40,000) for pension relief purposes, results in a reduced pension annual allowance of £35,000. Consequently, she incurs a 45% annual allowance charge on £5,000 of her employer’s pension contribution.

These examples show that families can save on taxes by transferring income from the higher to the lower earner, allowing them to benefit from the PA or lower tax bands and prevent reductions in PA or Child Benefit clawbacks. Achieving this can be challenging, but the following methods are allowed:

1. Gifting investments that generate taxable income.
2. Holding savings and investments in joint names to share the income.
3. Employing the spouse or partner in the other person’s business.
4. Inviting the spouse or partner to become a partner in the business.

It is essential to note that HMRC may challenge these methods if they suspect the transfer is not genuine. Therefore, it is always advisable to seek professional tax advice to ensure the success of your plan. If you need help to plan your taxes, please contact Tax Accountant at 0800 135 7323 or email info@taxaccountant.co.uk for expert advice.