17th October 2022
Government support and childcare
There are several Government schemes to support parents in raising children and paying for childcare. In each of the three schemes below, the thresholds on which they are withdrawn are assessed on the higher earner of both parents/carers. Thus, a distortion can occur where both parents have similar incomes below or at this threshold compared to an instance where one parent earns in excess and the other has no income.
Four example incomes are provided at the end of this article to highlight the marginal rate of tax in exceeding income of £100,000 and demonstrate the loss of two tax advantaged childcare schemes. We’ll see that earning even £1 over the £100,000 limit will cost over £10,000 in lost Government support.
Steps are provided to help reduce this excessive tax effect and keep access to Government even after earning over the thresholds.
Tax Free Childcare
Under the Tax-Free Childcare scheme, parents can create an account online and pay in money towards childcare costs. The Government tops up an extra 20% capped at £500 in any three month period (£2,000 pa per child). Childcare providers are paid directly from this account.
This scheme becomes unavailable where any one of the parent claimants has an income in excess of £100,000. If a household has two earners at £95,000 they will be able to claim, but if one is at £20,000 and the other at £105,000 this scheme is unavailable.
Strictly this £100,000 limit is assessed on “net adjusted income” which is:
Income for the year
Less: Gross gift aid contributions (cash donated ÷ 80%)
Less: Gross personal pension contributions (cash input ÷ 80%)
Adjusted net income
This limit has remained unchanged since introduction in April 2017 and with inflation rising and, as a consequence, wages rising, more parents may be caught by this.
In the event that a claimant’s income for the year just exceeds £100,000, then it would be of benefit to make a pension contribution or gift aid donation to bring their adjusted net income below £100,000.
This is also tax-advantageous since income between £100,000 and £125,000 suffers at a marginal rate of tax at 60% and making a payment to bring income below £100,000 would be saving this high tax rate.
As an example:
A parent receives a salaried income of £110,000
A personal pension contribution of £8,000 would bring the adjusted net income down by £10,000 (£8,000 ÷ 80%) to £100,000.
This would allow the £2,000 claim for one child under the Tax Free Childcare scheme.
It would also get higher rate tax relief at £2,000, and reinstate £5,000 of personal allowance, saving a further £2,000 of tax. Thus:
Net payment £ 8,000
Top up to H/R tax relief (£10k x 20%) £(2,000)
Reinstated personal allowance (£5k x 40%) £(2,000)
Tax Free Childcare top up £(2,000)
Net cost of pension contribution £ 2,000
Plus, the Government top up the £8,000 contribution to £10,000 in the pension. Therefore, for a cost to the parent of £2,000, they’ve achieved £10,000 extra in their pension.
Running the same example for two children in childcare would see a second £2,000 Childcare top up and therefore would effectively have nil cost.
This needs to be considered very carefully on a case-by-case basis as there are potentially expensive pitfalls depending on:
Child benefit
Child benefit in the year 2022/23 is valued at £21.80/week for the eldest child and £14.45/additional child. Therefore, annually valued at £1,133.60 for one child, £1,885 for two children, £2,636.40 for three children, and so on.
Child benefit must be claimed by an individual responsible for bringing up a child. It can only be claimed by one person and can be claimed until that child is 16, or 20 if in further education.
In the event that either the claimant, or the claimant’s partner, earns more than £50,000 in a tax year, the Child Benefit starts to be clawed back. This is assessed on the higher earner, whether or not they are the claimant. It is fully lost once the higher earner earns £60,000. In the event that each parent/carer in the household earns exactly £50,000 there will be no charge, but if just one of them earns £50,001 or above the clawback will start. For every £100 over £50,000, 1% of the Child Benefit received is clawed back.
Just as with the Tax Free Childcare, this £50,000 limit has not increased since being introduced in 2013 and more parents are finding themselves suffering the effect of the High Income Child Benefit Charge (HICBC).
Again, just as with the Tax Free Childcare, the £50,000 limit is assessed on “adjusted net income” and therefore pension contributions or gift aid donations can be used to bring a tax payer’s income below the threshold.
As an example:
The highest earner in a 3 child family earning £53,000 would lose 30% of their child benefit, equivalent to £791.
Making a £2,400 personal pension contribution would bring the adjusted net income down to £50,000, saving some higher rate tax at 20% (equivalent to £546), and saving the HICBC of £791. A net cost of £1,063 to receive a grossed up pension input of £3,000.
If the HICBC applies, then the higher earner is required to complete a Self Assessment Tax Return to calculate and declare the charge, even if it is to be paid via that earner’s tax code.
If a claimant or their partner is earning over £60,000 and not making efforts to bring adjusted net income down to £50,000, they will see the Child Benefit being fully clawed back through the HICBC. Child Benefit doesn’t have to be claimed, and so it might be tempting to simply cancel it at this point in order to save the hassle of submitting a Tax Return and repaying it, however there are other implications to claiming child benefit:
It is possible to claim Child Benefit but opt not to receive payments which gives the benefits of claiming without the hassle of suffering the HICBC and needing to prepare a Tax Return
Free Childcare Hours
In England, some 2 year olds are entitled to 15 free hours of childcare over 38 weeks if parents are claiming some income support benefits, universal credit, or receive tax credits and earn less than £16,190 a year.
In England, all 3 and 4 year olds are entitled to 15 free hours of early education or childcare over 38 weeks of the year; roughly the academic calendar. This applies to any approved childcare or early education setting such as childminders, registered schools, nurseries etc.
Some 3 and 4 year olds are entitled to 30 free hours over 38 weeks.
In order to qualify for 30 free hours each parent:
Adjusted net income is total income less gross pension contributions and less gross gift aid donations. In the event of earning more than £100,000 pension contributions or gift aid donations could be a good way of bringing income down to a level where these additional hours can be claimed.
With childcare costs at anywhere between £6 and £9/hour these additional 15 hours over 38 weeks (570 hours in total) could be worth between £3,420 and £5,130 per year.
These free hours can be used in conjunction with Tax Free Childcare.
Therefore, on top of the savings highlighted within Tax Free Childcare, bringing a parent’s income below £100,000 stands to benefit by another 570 free childcare hours a year.
Revisiting the example above where a parent of one child earned £110,000 and paid £8,000 net into a pension for a net cost of just £2,000, including an additional 15 free hours of childcare (at, say £7.80/hour) for now having an adjusted net income of £100,000 they stand to save £4,446 of childcare as well. Thereby, an £8,000 cash payment into pension has in fact created a position where the parent will be better off by £2,446.
Follow up
There are some big savings for falling on the right side of these thresholds and careful planning can save several thousand pounds per child per year, especially for those earning over £100,000.
Get in touch to discuss how you might benefit from carefully planning your position.
| Childcare tax/benefit withdrawal worked examples | |||||||||
| Income 1 | Income 2 | Income 3 | Income 4 | ||||||
| Total adjusted net income | 105,000 |
110,000 |
140,000 | 190,000 | |||||
| (after gross pension and gift aid contributions) | |||||||||
| Excess income over £100k | 5,000 | 10,000 | 40,000 | 90,000 | |||||
| Loss of Personal Allowance | 1,000 | 2,000 | 5,028 | 5,028 | |||||
| Higher rate tax at 40% | 2,000 | 4,000 | 16,000 | 20,000 | |||||
| Additional rate tax at 45% | – | – | – | 18,000 | |||||
| NIC at 2% | 100 | 200 | 800 | 1,800 | |||||
| 1 child in nursery (age 3-4) | |||||||||
| 30 hours free £7.80/hour | |||||||||
| 38 weeks/year | |||||||||
| 8am-6pm (10 hour/day) | |||||||||
| Total hours/year | 1,900 | ||||||||
| 15 free hours (at £7.80/hr) | 570 | ||||||||
| 15 extra free hours | 570 | 4,446 | 4,446 | 4,446 | 4,446 | ||||
| Remaining hours to pay | 760 | ||||||||
| Gross to pay | £ 5,928 | ||||||||
| Net of 20% tax | £ 4,742 | ||||||||
| Tax-free Childcare | £ 1,186 | 1,186 | 1,186 | 1,186 | 1,186 | ||||
| Extra tax/benefit withdrawn | 8,732 | 11,832 | 27,460 | 50,460 | |||||
| Effective rate of tax | 175% | 118% | 69% | 56% | |||||
Breakeven
Based on the criteria above for hourly nursery charge, number of children in nursery, and assuming all other qualifying criteria are met for the 30 free hours and Tax Free Childcare, the breakeven point is £118,378.
That is, receiving £18,378 over the £100k threshold gives rise to a tax/ benefit withdrawal total of £18,378.
Earning between £100,000 and £118,378 will cost more than if the income had stayed at £100,000.
