Threshold tax and benefit traps on families

When more can mean less

The thresholds for income tax are generally well known and have predictable effects when exceeded. However, less well understood thresholds exist and can result in surprisingly high tax rates. In 2023/14 for example:

• £50,000, which triggers the high income child benefit charge (HICBC); and
• £100,000, which results in a phased reduction in the personal allowance and withdrawal of all childcare subsidies.

Example - child benefit trap

Florence, who has four children, is due a bonus from her employer. For most people this would be a good thing, but in Florence’s case tax and benefit cliff edges will result in tax trouble. Florence’s child benefit for four children is £3,728 for 2023/24. If the bonus takes her adjusted net income over £50,000, the HICBC kicks in to claw back £37.28 of child benefit for every £100 of excess income. This means her marginal tax rate is over 79%, i.e. for every extra £1 of the bonus she receives between £50,270 and £60,000, she only gets to keep 21p (Scottish tax rates are even higher). As Florence has a student loan she also loses an extra 9% of her bonus in additional repayments. Some good news for Florence is that the 2024 Spring Budget announced that the withdrawal threshold is increasing to £60,000, and the abatement rate reduced to 1% for every £200 of excess income.

In extreme cases the marginal tax rate on additional income can exceed the income.

Childcare and personal allowance traps

It gets even worse where adjusted net income exceeds £100,000, with the double-whammy of the loss of both childcare support and the personal allowance. This cliff edge is so bad that a parent on £115,000 can be left with less than someone whose income is £95,000. Childcare support currently takes the form of:

• tax-free childcare which is a subsidy scheme for children under eleven; and
• 15 free nursery hours for 38 weeks p.a. for pre-school children of working parents (the so-called 30-hour offer).

If income exceeds the £100,000 threshold by just a matter of pence, all of this support disappears for every child and the personal allowance is withdrawn by £1 for every £2 of extra income up to £125,140. By contrast, two parents each earning £99,999, i.e. a household income of £199,998, retain all of their childcare support and full personal allowances.

From April 2024, working parents of two year olds will also be eligible for 15 free nursery hours, extending to 30 hours from September 2025.

If Florence has two pre-school children and two others under eleven, she loses around £18,000 in childcare support if her income exceeds £100,000. With a bonus of £20,000 on top of her usual salary of £95,000, she’ll be worse off until her income reaches just over £136,000.

There are simple steps Florence can take to reduce her tax. She could make additional pension contributions. While this won’t increase her net available income it improves her overall finances by increasing her pension savings. Another option is for Florence to ask her employer for tax-efficient benefits in kind, e.g. an electric company car in lieu of a cash bonus.