Written by Laura Suter, head of personal finance at AJ Bell
Parents who hit the £100,000 earnings threshold will be hit with a crippling effective tax hit once the new free childcare hours scheme comes in.
The government system means that anyone who hits £100,000 of earnings hits a cliff edge where they lose two lucrative parts of childcare support: tax-free childcare and the free childcare hours.
Jeremy Hunt’s extension of the 30 free hours scheme means that more parents will have two pre-school children they can claim the hours for, which is great news, until they hit this earnings threshold and lose it all in one fell swoop.
Parents in areas where childcare is most expensive will be hit hardest, as those 30 free hours a week will cost far more. Someone in inner London, where costs are highest, who is claiming for two children will lose a benefit worth £23,300 a year just in free childcare hours*. On top of that they lose their entitlement to tax-free childcare, which is worth up to £2,000 per child each year. It means that when one parent gets a pay rise taking them over that £100,000 limit, they lose £27,300 of entitlement in an instant.
What’s even more eye-opening is just how long it takes before their disposable income will resume to their previous levels, accounting for post-tax income and the value of the childcare support. Their salary would need to increase to £156,279 before they get back to the same disposable income as when they were earning £100,000. This puts parents in the ridiculous place where they are effectively worse off earning between £100,000 and £156,000.
The figures for the England average childcare costs are slightly lower, but equally stark. That same parent claiming the 30 free hours for two children, plus the tax-free childcare, will be getting childcare support worth £21,718 a year. If they tip over the earnings threshold it would take until they earn £146,114 before their disposable income is back to where it was when they earnt £100,000.
The cliff edge rule makes the tax system punitive for those getting even small pay rises, and there is still time for the government to change the system to either remove the threshold or at least taper it to ensure that the support is gradually withdrawn, as it is with child benefit.
Any parents caught in this tax trap now can funnel the money into their pension instead. The £100,000 threshold is your income minus any pension contributions, meaning that increasing your pension payments could bring you back under that crucial threshold.
London example:
| One working parent of two pre-school children – in London (inner) | ||||||
| Salary | Tax | NI | 30 free hours for two children | Tax free childcare for two children | Take home pay (including childcare benefits) | Salary you’d require before you hit the previous take-home pay |
| £100,000 | £27,432 | £5,519 | £23,300 | £4,000 | £94,350 | NA |
| £101,000 | £28,032 | £5,539 | NA | NA | £67,429 | £156,279 |
| Source: AJ Bell, Coram Childcare Report. Figures assume no pension contributions, student loan payments or other deduction, that salary is paid as income, not dividends. |
England average:
| One working parent of two pre-school children – in England | ||||||
| Salary | Tax | NI | 30 free hours for two children | Tax free childcare for two children | Take home pay | Salary you’d require before you hit the previous take-home pay |
| £100,000 | £27,432 | £5,519 | £17,718 | £4,000 | £88,768 | NA |
| £101,000 | £28,032 | £5,539 | NA | NA | £67,429 | £146,114 |
| Source: AJ Bell, Coram Childcare Report. Figures assume no pension contributions, student loan payments or other deduction, that salary is paid as income, not dividends. |
*Based on hourly rate in Coram Childcare report, assuming the government pays the full rate for those hours.
