The tax perks parents in single-income households should know

When children come into the picture, many couples decide to transition to one parent remaining at their job and one staying at home to raise their child. This is a very personal decision. There is no right or wrong answer to managing the demands of a family. But going down this route does mean a big shift in your lifestyle and finances.

Single-income households can sometimes face more tax than dual income, because tax rates are applied to people individually instead of spread across both parties. For example, two parents making £40,000 each would have a larger take-home income than one parent earning £80,000, because they pay the higher rate of tax. It also makes parents ineligible for some benefits, such as tax-free childcare and additional free (funded) childcare hours. But there are many benefits to it as well, and if you’ve decided a single-income household is the right choice for your family, there’s a few policies to be aware of that could save single-income households thousands.

Some of these rules will apply to anyone in a partnership, but for others, you will need to be their spouse or civil partner. In general, spouses and civil partners receive much more flexibility in sharing their finances under HMRC regulation.

Paying into your partner’s pension

A partner not earning income can still put £2,880 into their pension each year, with government tax relief applied at 20%, making the total contribution £3,600. This could be useful if the working partner has used up their own pension contribution limit of the lower of £60,000 or 100% of their salary, as they can contribute the additional amount to their partner’s pension.

If the working partner is a higher or additional rate taxpayer, it typically makes sense for that partner to use up their own allowances first, because they will be getting relief at the higher rate or additional rate for income tax, instead of the flat 20% offered to the non-working partner and may be getting employer contributions on top.

Let’s see how this works in an example: One parent, Sam, earns £175,000 each year and already contributes £60,000 to his pension, that he receives additional-rate tax relief on. His husband, James, has decided to stay at home with their child, so they will now be a single income household. Sam can contribute £2,800 of his income to James’s pension, and James will receive tax relief at a rate of 20%, for a total of £3,600. This way, both in the couple are using their full tax allowances for their pension.

This still means the stay-at-home parent is getting much smaller contributions, so it’s worth having a conversation with your partner about how finances will look in retirement when you are relying on those pots for income.

Taking advantage of childcare benefits

Knowing what childcare benefits are available to you can easily save you thousands, and you can get details here. The main entitlements for families with a stay-at-home parent include the free (funded) hours childcare scheme and child benefit.

To be eligible for child benefit, which is a weekly rate of £27.05 for the eldest child and £17.90 for any additional children, both partners must earn under £80,000 with reductions for benefits beginning at £60,000. For free childcare hours, all parents will have access to 15 hours each week. To gain any additional hours, both parents would need to be working, and no parent could have an adjusted net income above £100,000.

Saving efficiently

Those who are spouses or in a civil partnership can transfer money between them with fewer tax implications. Even if only one person is earning the money, they can use their own ISA allowance of £20,000 and then gift another £20,000 to their spouse or civil partner to be invested in their ISA. However, once that money is gifted, it is legally theirs.

For those couples that are fortunate enough to use up both of their ISA allowances, it can also be more tax-efficient to invest in the name of the stay-at-home parent rather than the working parent, because they will be taxed at the basic rate for income and capital gains tax, as well as having their full personal allowance of £12,570 still to use.

Let’s take another couple, John and Melanie. John has savings worth £100,000 outside of an ISA and earns £150,000 each year, and Melanie is a stay-at-home parent. In this tax year, John puts £20,000 in a Stocks and shares ISA, and to invest most tax-efficiently, gifts another £20,000 to Melanie, who puts that money in her own Stocks and shares ISA. However, John still has £60,000 of savings held outside of and ISA and is classified as an additional-rate taxpayer. This means that if he invests the money, any capital gains he makes will be taxed at a rate of 24%, and any income he makes from dividends on his investments will be taxed at 39.35% once he’s used his £500 allowance.

Instead, he decides to gift that money to Melanie. Melanie will be taxed the basic rate of 18% on any capital gains, after using her £3,000 allowance. For dividend payments, she will have a £500 allowance and be able to use her personal allowance of £12,570. Then, any amount after that will be taxed as dividends at 10.75%. If John held onto the money and made £15,000 in dividends, he would have to pay £5,705.75 in dividend tax, taking the dividend payment down to £9,294.25. But if the money was held in Melanie’s name instead, there would only be £207.48 to pay in dividend tax, leaving them with £14,792,52.