The loss of free childcare: a 97% marginal rate of tax

NOTE: This post is more than 12 months old, and the information contained within may no longer be accurate.

Over the years the Government have made changes to help individuals pay for childcare. The latest scheme offers up to £2,000 of Government funding on up to £10,000 of childcare.

Furthermore for those with children aged 3 or 4, in England, an additional sum is available to fund for early education or childcare.

The free childcare must be with an approved childcare provider and stops when a child starts “reception” or compulsory school age, if later, and can be removed under some other limited circumstances.

In Surrey, 30 hours of childcare is worth around £10,000 per annum, based on current costs and all of this sum is lost completely for those earning over £100,000 in any tax year.

The implication of this is that whilst somebody earning £99,999 can have £10,000 free childcare allowance (if other qualifying criteria are met), an individual earning just £100,001 gets no benefit. In other words a trivial pay rise could see a loss of a £10,000 net benefit.

Furthermore, at this level of earnings the personal allowance is lost at the rate of £1 of allowance for each £2 of income above this threshold. This means the individual with children aged 3 and 4 earning £123,700 is only around £760 better off than an individual earning £99,999.  After tax and national insurance, but with no other deductions, the £99,000 earner has £66,000 of net income and the £10,000 free childcare, but the individual earning £26,700 more has £76,760, but no free childcare, quite the marginal tax rate (97%)!

A potential solution could be to make a gift or pension contribution to keep below this threshold.

Using the example of somebody earning £123,700 a gross personal contribution of £23,700 after all tax relief is given would only cost £9,480. This individual would also then qualify for the £10,000 childcare meaning that the “loss” of £9,480 net income adds £23,700 to the pension and gets £10,000 of free childcare, extremely tax efficient (assuming relevant allowances are available).

There are other situations where childcare can be removed for example for those who are not EU residents etc. but this position for higher earners is one of the more insidious. If you would like to discuss this further please do not hesitate to get in contact or for more information please read the Government website.

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