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 Child Benefit is withdrawn based on the income of the higher earner in a couple, irrespective of who receives it.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 earn just enough each to cover their basic Personal Allowance (£12,500 for 2019/20) and the basic rate band. The thresholds for restricting Child Benefit (£50,000), Personal Allowance (£100,000) and Pension Annual Allowance (£150,000) 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 2019/20 George Brown earns £90,000 and pays higher rate tax, but Sally Brown has no income. Because George’s income is over £60,000, the family’s 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 Personal Allowance and most of their basic rate band.
Roger and Rose are in a worse tax position. Roger’s total income is £160,000 and his employer contributes £40,000 into his pension scheme. Roger and Rose have no effective Personal Allowances, as Rose has no income to set her allowance against, and Roger’s Personal Allowance is entirely withdrawn because his income exceeds £125,000.
Roger is treated as having income of £200,000 (£160,000 + 40,000) for pension relief purposes. His pension annual allowance is therefore reduced to £15,000, so he suffers an annual allowance charge at 45% on £25,000 of pension contribution.
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 Personal Allowance or lower tax bands, and to avoid the clawback of allowances. This is not always easy to do, but the following methods are permissible:
• make an outright gift of investments which 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.