What a dilemma! I’m the first to agree the benefits system is bloated, and that we’d do better tackling income inequality through an overhaul of the tax system – as opposed to politicians bribing us with our own money through welfare payments, tax perks, and other kickbacks.

On the other hand, you’re my dear readers, and many of you stand to lose your child benefit next year.

From January, the government will begin clawing back child benefit from any parent with an income of more than £50,000 a year.

A three-child family where one parent earns more than £60,000 is set to lose £2,449 a year – an enormous wodge of tax-free income.

One person’s child is another person’s tax bill

Now, we could debate the politics of welfare all day (let alone the ethics of having three children).

Supporters of universal child benefit argue that an income of £50,000 isn’t any great shakes, especially in the South East.

Buying a house with room for a kid or two is already a Herculean feat for anyone down here without a rich benefactor (a parent, a lottery win, a bank bonus, or a mortally-challenged grandparent). And do we really want a society where only the poor can afford to have kids?

I’d retort that London property prices are just as high for me – a parentless singleton – and yet I don’t get a handout from the public purse.

Moreover I see people wasting money all day long, especially middle class parents.

Slightly more tongue-in-cheek… I need to secure my financial future even more than a parent does, because there will be no spare bedroom in my daughter’s house in my wrinkly decrepitude.

So why should my taxes pay for someone else’s Bugaboo Lambskin Footmuff?

In an over-crowded world I’m also sceptical of the argument that parents are bringing up future taxpayers on my behalf.

That’s the economics of a Ponzi scheme, and one ill-suited to a planet with limited resources.

You can keep your child benefits and retire richer

But enough! Let’s bury the hatchet, team!

Let’s concentrate on helping those Monevator-reading parents whose child benefit is set to go the way of sex, a good night’s sleep, and skinny jeans.

In this post I’ll explain how you can keep your child benefit and retire richer, too.

You’ll still have to cut back on your spending, admittedly.

But I’m pretty sure I could drive a lawnmower through the average £50,000-earner’s verdant budget, so I don’t think that should be an obstacle for most people who put their mind to it.

Besides, this strategy enables you to keep getting free money from the taxpayer – from the likes of me.

So if you’re still complaining, stop it and start saving instead.

How child benefit will be cut

Official letters explaining how child benefit will be withdrawn started going out this week (at great expense to all of us, I might add).

It’s estimated 1.2 million households will be affected by the changes.

The key to keeping your child benefit is to understand how this withdrawal will work.

Currently, child benefit is paid as:

• £20.30 a week for the first child

• £13.40 a week for additional children

So a two-child family for example receives:

£20.30 + £13.40 x 52 = £1,752 a year

But from January 7th, households where one or both parents individually have an income of more than £50,000 a year will start to see the benefit tapered down.

Note that some people (including a few journalists) seem to think that a combined household income of over £50,000 will trigger the tapering.

This is incorrect.

One of you needs to be earning more than £50,000. So if you are earning £30,000 and your partner earns £20,000, say, you’re not affected by the changes.

Child benefit will be clawed back as follows:

• For every £100 earned over the £50,000 threshold, 1% of the benefit will be taken back.

• You’ll still receive the benefit (unless you opt-out, though you should probably always claim it). But it will later be clawed back via a new extra income tax called the High Income Child Benefit charge.

• This will happen via your self-assessment tax return.

• At an income level of £60,000 and beyond, you’ll receive no benefit because it will have all been tapered away.

Note that ‘income’ here comprises money earned from all sources, including savings interest and dividend income, as well as any income from rental properties. Anything you’d declare to the taxman, basically.

It’s yet another reason to house all your investments in a tax-efficient ISA – because income generated within an ISA doesn’t count towards the £50,000 threshold.

Finally, as I understand it (as a non-parent) the child benefit is always paid to the mother. It should be clear from my notes that either parent can be hit by the High Income Child Benefit charge, though – which is bound to cause some unintended consequences, given the multiplicity of child-raising set-ups nowadays.

Losing child benefit is like paying a higher tax rate

A better way of looking at the withdrawal of child benefit is as a higher tax rate on a parent with an income of £50,000 or over, compared to those with incomes of less than the threshold.

Depending on how many children you have, if you’re over the threshold your marginal tax rate could increase to 50.5%, 57.5%, or even higher.

For example, someone on £60,000 with two children will pay an extra £1,349 in tax:

For one child, this creates a marginal rate of tax of 50.6% on the slice of income between £50,000 and £60,000. For two children, the marginal rate is 57.5%. It increases by about 7% for each subsequent child. For eight children, the marginal rate is 99%; for nine, the marginal rate is 106%.

Because the new charge is being introduced in January, there’ll only be a limited amount of damage done in the current tax year, which runs until April.

From April 2013 onwards though, all your child benefit will be fair game.

Use a pension to reduce your income

To keep all your child benefit, both parents need to earn less than £50,000.

If one or both of you is unfortunate enough to enjoy a higher income, here are a few things you can do about it:

• Split up with your higher-earning partner

• Tell your boss you will work for free from now on

• Tell your husband, wife, or whoever, that they can quit their high-paying job, in return for certain non-taxable favours

• Use big pension top-ups to bring down your taxable income

I’m guessing the final option – increasing your pension contributions – will be the most palatable for Monevator readers (though as I haven’t met your spouse, I could be wrong.)

Topping up your pension to reduce your income is a simple way to keep all your child benefit – provided you don’t earn too much or you’re sure you’ll die before you’re 55, and so be unable to ever spend it.

The maths is straightforward.

Let’s say you’re the sole earner in your house, and you make £55,000 a year.

Increasing your pension contributions by £5,000 a year will reduce your income to £50,000. You’ll therefore keep all your child benefit.

If yours is a two-income family and you both earn over £50,000, then you’ll both need to make the extra top-ups to take you both below the danger zone.

This is all legal, in case you’re wondering. (Recall the difference between tax evasion and avoidance).

And in my opinion, doing so is well worth it.

A higher-rate taxpayer with two kids who uses extra pension contributions to reduce his or her income enough to keep all their child benefit will be paying roughly 43.5p for every £1 that ends up in their pension1.

That’s a very nice return, even before you’ve invested a penny!

Still earning too much?

I do appreciate that child benefit is not designed for boosting the pensions of the middle classes.

As I said at the start, I’m just telling you how to do it, not passing moral judgement. I didn’t invent the Byzantine tax and welfare system, and if I did, it wouldn’t look like this.

More to the point, some people will earn too much for it to be practical to retain child benefit solely through higher pension payments.

My sympathy is limited the richer you are – as I said, I don’t like paying for mini-pashminas and pony lessons – but nevertheless, I’d suggest there may be other ways you can further bring down your income.

You might be able to sacrifice some salary in return for other company benefits or for childcare vouchers, for example.

It might even be possible to tilt your remuneration towards very long-term share options or similar, though you’ll need to do a lot of homework, and probably take professional advice.

If you earn more than £50,000 because you have savings or investments generating income outside of an ISA or pension (and you’re more confident in the stability of your relationship than I ever would be) then you might want to consider transferring some assets to your lower-paid partner. (Make sure doing so doesn’t take their total income over the £50,000 threshold, obviously).

Worst comes to worst, you could even send the big earner abroad, since high earners working overseas may be able to keep their full child benefit.

Important: None of this is tailored advice for your circumstances, and I’m not a tax adviser. Get professional advice if you’re unsure.

Living a £50,000 per year lifestyle

The elephant in the room, of course, is that you can’t spend your pension until you’re, well, a pensioner.

Though you’ll be quids-in eventually by paying more into your pension pot – thanks to the generosity of your fellow taxpayers – you’ll still need to earn enough income now to keep your little darlings alive enough to qualify for child benefit, as well as whatever else you consider an essential.

I’m afraid there’s nothing I can suggest here but to take a scythe to your budget. Only you can work out what’s dispensable for you and what’s non-negotiable.

As for the little cost centres, they could always get a paper-round…

Economics by Kafka

If you’ve ever wondered why the tax system is so vast and unfathomable, child benefit and this clumsy attempt to taper it down provides a perfect case study.

A silly system is being redressed with an even sillier system, at great expense and hassle for everyone – including HMRC – and despite the creation of huge inconsistencies.

It’s also a truly strange policy to see coming from a political party that sings the praises of old-fashioned families.

The jammiest couples who follow the strategy I’ve outlined will be working parents on say £55,000 a year each, who both do £5,000 in extra pension payments. They’ll keep all their child benefit despite having a household income of £110,000 a year, and they’ll have a nicer retirement.

In contrast, a sole earner in the South East on £60,000 who can’t afford to reduce his or her income by £10,000 because they’re shouldering a massive mortgage, commuting costs and all the rest, will lose all their child benefit.

Indeed, if you wanted to design a policy to encourage both parents to work full-time, you could do a lot worse. And that was probably not the idea.

Remember that the next time a politician talks about being “fair”.

Further reading:

• HMRC has been lumbered with an extra 500,000 self-assessment tax returns to process due to the High Income Child Benefit charge. No wonder it’s trying to head-off queries with a lot of information.

• Use its simple online checker tool to see if you’re affected by the changes.

• Here’s another tool, which enables you to estimate the High Income Child Benefit charge you’ll pay.

• MoneySavingExpert has created a very readable FAQ.

• I’m not a lone nutcase. It’s taken me all week to write this post (hence its going up late on Friday!) and as the week has gone on I’ve noticed several other sites advocating pension top-ups as a solution to these child benefit changes. Read widely, and see how the numbers work for you.

1. Or even less if you take National Insurance into account [↩]

Are you saving enough for retirement, and will your retirement plan survive a damn good buffeting by an uncertain future? Obviously nobody knows, but you can stress test your strategy with a Monte Carlo simulator.

A Monte Carlo simulator takes your predicted pension pot and pits it against multiple visions of the future. It subjects your portfolio to random return sequences to determine the chances of your money running out before you breathe your last.

Staying in the black until you cark it is a win.

In contrast eating dog food in your eighties is not shown, but is the unsavoury implication of failure.

Retirement roulette

In some return scenarios, the 1980s dream sequence for equities will bubble into the dot.com boom and turn you into a multi-millionaire.

In other possible worlds, you’ll get hit by the Great Depression then World War 2 then the 1970s oil crisis, coming one after the other, like the three buses of the Apocalypse.

The main interest lies in the big % number written on your scorecard at the end. Handed out, as if Death himself was a Strictly judge, this shows the likelihood that you haven’t emptied your pot before you’ve completed the waltz of life.

To run a stress test on your own retirement plan, head to Vanguard, which hosts a free Monte Carlo retirement calculator that’s very simple to use.

The calculator wants to know:

Your total pension pot – I used the figure projected by Hargreaves Lansdown’s calculator based on my existing salary and contributions (as we’ve previously discussed). Ignore the Vanguard calculator’s request for your portfolio’s balance today. Instead insert your projected pot as it will stand on the day you retire (but in today’s terms).

The annual income you require 1 – I used my current budget because I’m already a money-saving maven. I’m not going to spend much less in retirement unless I’m afraid to leave the house. If you’ve never imagined what your retirement income might look like, try this suggest-o-tron.

How long you plan to live – Use the national averages, or try a life expectancy calculator, or accept the 30-year default.

Your asset allocation – Use your current risk tolerance and these rules of thumb to guesstimate your likely asset allocation when you’re retired. Once you start playing with the calculator you’ll discover that there’s much less room for manoeuvre than you might imagine.

Place your bets

Run the simulator, let the digital dice roll, and you’ll end up with something like this:

The green zone represents all the time streams in which I lived happily after. The orange area shows the scenarios in which I bitterly regret not having children. In the worst-case scenario, the money tap runs dry after 16 years.

The important number is 78%. That’s the probability of my portfolio lasting for 30 years based on every scenario in the sim.

That’s not great. I’m not prepared to risk a 1-in-5 chance of hitting the skids.

Options for remedial action

So what am I to do?

Well, I could plan on cashing in my chips earlier.

Hmm.

What else? I can spend less, retire later, save more, and invest more aggressively.

Sticking with the moveable parts of the calculator, I try upping my equity allocation. But I can only hit an 81% success rate even with portfolios of 50 – 75% in shares. Not good enough.

Time to pinch the pennies. I can reach an 88% survival rate by spending only £18,000 a year. 10% less than I planned. This I can live with.

To hit the magic 100%, I either need to exit the stage after 20 years or get austere on my ass and only spend £12K a year.

A kick in the assumptions

For simplicity’s sake, I haven’t taken into account my state pension or the fact tax would reduce my £18K spending money to £16.5K. Do work these factors into your own retirement plan.

UK investors should bear in mind that this is an American calculator that uses historical US asset return data (from 1926 to the present day).

Many commentators argue that this was a golden age for US assets that’s unlikely to be repeated. On top of that you can knock off about a point of growth every year to represent UK returns lagging the US.

As the returns data is based on indices, there’s also every chance that the simulator doesn’t take into account investment fees (although it doesn’t say so in the fine print), which will deplete a pot even faster.

Not including my state pension makes my results conservative enough to allow me to feel comfortable about the above issues, however.

Another thing to keep in mind is you don’t know how often you ran out of money with, say, less than 24-months on the clock. Quality of life may not matter as much near the very end.

Lastly, this kind of calculator assumes you draw down your portfolio until it runs out or you do. In reality, you may want to annuitise a large proportion of your pot and take the guessing out of the game. But that’s a different story.

This is the end, my friend

For all these reasons and more, you shouldn’t treat these numbers as gospel. At best they enable you to circle within the vicinity of your retirement destination. They’re not exact co-ordinates.

Darrow KirkPatrick from the excellent Can I Retire Yet? blog advises using several different retirement calculators. That way you’ll get a range of answers that would make an astrologer sound precise. The process should dispel the notion that there’s one, ‘true’ number to shoot for.

I highly recommend trying Firecalc – it’s an excellent Monte Carlo sim with all kinds of tweakable options. Too much fun.

The vagaries of these calculators become a metaphor for the uncertain future ahead. Because however your retirement plan turns out, for better or worse, it won’t return the same answer as the calculator.

Take it steady,

The Accumulator

1. Again, enter your desired income in today’s money. [↩]

Good reads from around the Web.

A post of the week. Here’s Josh Brown at The Reformed Broker warning about an inevitable crash in the bond market:

I’m going to say this here and now for posterity and I hope you bookmark it:

There’s going to be such a brutal bond investor slaughter at some point over the next decade that the streets of Boston’s mutual fund district will run red with blood, the skies will be shot through with the lightning and thunder of unexpected capital losses and those who manage to survive will envy the dead.

Now a slaughter in bonds will not look like an equity market crash, the volatility characteristics are different and bonds eventually mature. But in some ways it will feel much worse than a stock crash because the money parked in bonds is thought of as low or no-risk.

The fixed income guys know what’s going to happen, too. Why do you think the Bond Kings at PIMCO and DoubleLine are pushing into equity funds? They’re getting three-year track records under their belts for when the big switch comes.

One reason Josh Brown is an excellent writer and pundit is because he doesn’t prevaricate. It may not be good advice – I have no idea about his track record, either way – but it grabs you right in your special interests.

In contrast, while I happen to think Brown is likely right about bonds, I’d feel duty bound to caveat it with warnings about deflation, Japan, market timing, and 20-year bear markets.

In fact, I already did. Some of my readers may have ended up wiser for it, but I suspect a few of them ended up asleep.

Brown’s is the strategy of a Wall Street professional. If he’s right, he can point to his prediction for years to come. If he’s wrong, nobody will ever remember – maybe not even Josh Brown, thanks to hindsight bias.

Perhaps even Google will forget his page eventually.

It’s a great post – and I think likely a good call – but it’s not necessarily correct.

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