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How Child Tax Credit Works

Kids | Saving for Children

By Justin Modray, published 24 June 2010.
Helpful? 20

The Budget Child Tax Credit announcements will hit the pockets of many families. But do you know how the system works? No? Don't worry, I didn't either, so here’s a simple guide.

I remember swotting up on tax credits a few years for a TV interview, but forgetting it all straight afterwards. So when changes to the Child Tax Credit were announced in this week’s Budget it seemed a good time to revisit this overly complicated system and try to understand how the changes might affect families with children.

What is Child Tax Credit?

Child Tax Credit (CTC) surprisingly has nothing to do with tax. It’s simply a state benefit payment that, depending on your household income, you might be entitled to if you have children.

It’s made up of two parts: a family element of £545 per year (double in the year after a child is born) and a child element of £2,300 per child per year.

CTC is paid until 31 August after a child’s 16th birthday, but can continue provided they’re under 20 and in full-time non-advanced education or training (includes A Levels).

How much do I get?

That depends on the level of your household income, including earnings, savings, investment and rental income. It also depends on whether you’re receiving Working Tax Credit (more about that later), but for now let’s keep things simple and assume you’re only entitled to CTC.

Start by working out the maximum CTC you can receive. If you have two children, of which one has just been born, this will be: £545 family element + £545 new baby element + 2 x £2,300 child element = £5,690.

If your household income is below £16,190 (called the ‘First Income Threshold for CTC only’) then you receive the full amount. Otherwise the child element is reduced by 39p for every £1 your income exceeds the threshold (called the ‘First Withdrawal Rate’). Based on this you’ll lose the entire £4,600 if household income exceeds £27,985.

The family element (including the extra new baby element) is instead subject to a ‘Second Income Threshold’ of £50,000 and reduces by £1 for every £15 household income exceeds that threshold (‘Second Withdrawal Rate’). So you’ll lose this allowance altogether if income exceeds £58,175 (£66,350 if also receiving the new baby element).

Examples

Assume a couple with two children (not newborn) entitled to CTC only – current tax year rates (rounded by £5).

Household IncomeFamily ElementChild ElementTotal
£25,000 £545 £1,170 £1,715
£35,000 £545 £0 £545
£45,000 £545 £0 £545
£55,000 £210 £0 £210

What if income increases during a year?

Income rises of up to £25,000 (compared to the last tax year) are disregarded in the year they take place. The rationale is not to penalise a partner for starting/returning to work in that year (£25,000 being the average wage).

What are the Budget changes?

From 6 April 2011:

  • The First Withdrawal Rate is rising from 39p to 41p in every £1.
  • The Second Income Threshold is falling from £50,000 to £40,000.
  • The Second Withdrawal Rate is rising from £1 in every £15 to 41p in every £1 (family element will be lost if income above £41,330).
  • Income disregard is falling from £25,000 to £10,000.
  • The new baby element of the family element will be scrapped.
  • The child element will increase by £150 above inflation, but CPI not RPI.

From 6 April 2012:

  • The Second Income Threshold will be scrapped and the family element will be withdrawn straight after the child element.
  • Backdating of claims will be reduced from 3 months to 1 month.
  • If income falls during the year the first £2,500 will be disregarded.
  • The child element will increase by £60 above CPI.

From 6 April 2013:

  • Income disregard will fall to £5,000.

What impact will these changes have?

Let’s revisit our example: 2011/12 - assume CPI 2.7%, so family element £545 (it’s frozen), child element £2,515 per child and first income threshold £16,630:

Household IncomeFamily ElementChild ElementTotal
£25,000 £545 £1,600 £2,145
£35,000 £545 £0 £545
£45,000 £0 £0 £0
£55,000 £0 £0 £0

2012/13 - assume CPI 2.4%, so child element £2,640 and first income threshold £17,030:

Household IncomeFamily ElementChild ElementTotal
£25,000 £545 £2,015 £2,560
£35,000 £0 £0 £0
£45,000 £0 £0 £0
£55,000 £0 £0 £0

As you can see, if your household income falls between about £30,000 to £55,000 then expect to lose up to £545 a year. But good news if your household income is around £25,000 or less.

What about other tax credits?

I’ve tried to keep things simple by only focussing on CTC. There’s also Working Tax Credit (WTC), which tends to apply if you’re working on a low income and this can affect CTC, but we won’t go there...you’ll probably fall asleep reading it and I’ll certainly fall asleep writing it!

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