Tax Free Childcare

With an increasing number of families juggling work with raising a family, the government has introduced a number of initiatives to help with childcare costs. In April 2017 the Government launched a new childcare scheme, Tax Free Childcare to help working families with childcare costs. The qualifying criteria and benefits are outlined below:

TAX FREE CHILDCARE (TFC) - HOW THE SCHEME WORKS

Under this scheme working parents whether employed or self-employed are required to set up an online childcare account. For every 80p paid into the account the Government will add 20p. The scheme can be used to pay for up to £10,000 of approved childcare per child per year, and this would include the maximum government contribution of £2,000. The basic rate tax paid on the taxed income used to pay into the scheme is essentially refunded. The funds are then used to pay the childcare provider.

ELIGIBLITY

The scheme is for parents of children up to the age of 11. Children stop being eligible on 1 September following their 11th birthday. A single parent can make a claim or a couple can make a joint claim. To qualify, the claimant(s) must both work and each earn at least £131 a week (roughly equivalent to 16 hours per week at the national minimum wage). Claimants must not have annual income in excess of £100,000 per person. You are not entitled to TFC if you receive childcare vouchers/directly contracted childcare or claim tax credits or universal credit.

WHAT IS APPROVED CHILDCARE?

Tax-Free Childcare covers breakfast clubs, after school clubs, nurseries, playgroups, nannies and au-pairs. The provider must be registered with a regulator such as Ofsted, the Early Years Register or the Childcare Register to count as childcare – and it must also be registered with the Tax-Free Childcare scheme (you can check this when you sign up for the scheme).

APPLY

To complete the application, you need to provide your name, address and national insurance numbers, as well as whether you expect to meet the income requirements over the next three months and whether you are in receipt of any benefits. If you are self-employed and do not expect to make sufficient profits in the next 3 months, you can use an average of how much you expect to earn over the current tax year. Please follow the link to apply for a childcare account.

TAX FREE CHILD CARE AND EARNINGS OVER £100,000

The Tax Free Childcare scheme is not available where a claimant has annual income of more than £100,000. The test is on ‘adjusted net income’ which takes into account gross personal pension contributions and charitable donations made under gift aid. This means that you can use pension contributions or gift aid payments in order to reduce your adjusted net income below £100,000. Another benefit of having adjusted net income below £100,000 is that it avoids an effective rate of tax of 60% on non savings income falling between £100,000 and £125,000. This ensures that the tax free personal allowance is preserved. A worked example is shown below:

A couple have two qualifying children and childcare costs of £20,000. If one parent earns £105,000 then they could potentially lose out on £4,000 from the Tax Free Childcare Scheme. However, a net personal pension contribution of £4,000 would reduce their adjusted net income below £100,000. From a cash flow perspective, please see below:

• The net contribution will cost £4,000, with basic rate tax relief given at source.

• Higher rate tax relief will be available, and as the higher earner’s income was over £100,000 further relief will be available as their personal allowance is no longer restricted. This reduces the effective cost of the pension contribution by a further £2,000 (being £1,000 of higher rate tax relief on the pension contribution and £1,000 from the reversal of the personal allowance restriction).

• The Government will contribute £4,000 to the childcare account.

• The net result is an annual cash flow benefit of £2,000 to the family, while the higher earners pension pot benefits from an additional annual contribution of £5,000. 

Please note that tax planning should be on a case by case basis taking into account the actual childcare costs and the higher earner’s annual allowance for pension contributions. The annual pension allowance is reduced by £1 for every £2 of adjusted income above £150,000. Thus, reducing the annual allowance to £10,000 for individuals with adjusted income of £210,000 or more.  

Click here for more information about the different childcare options available to you.

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