Broken tax system risks punishing working parents

The government provides two main ways to help working parents with their childcare costs. One is tax-free childcare where the government tops up £2 for every £8 they put into a special account to pay their childcare provider, up to a limit of £2,000 per child.

The other is free childcare hours, which vary depending on the age of your child and your income. In England, all three and four year olds get 15 hours a week of free childcare, but if both parents work and earn less than £100,000 each, they can get 30 hours a week. The government is expanding the scheme to cover younger children, and from September 2024 working parents of children aged nine months and older will be entitled to 15 hours a week too. 

Considering these 15 hour blocks are spread over 38 weeks, at an average childcare cost of £5.50 per hour, this is equivalent to a cash benefit of £3,135 per year. When combined with tax-free childcare, working parents may presently receive up to £5,135 in government support per child.

Where either parent has an “adjusted net income” of more than £100,000, they will lose both valuable childcare subsidies in full. As result of this cliff edge, a working parent who earns just £1 above £100,000 could suddenly find themselves £5,135 worse off than if they were earning £99,999. If they have two or more children, the financial impact is even bigger.

For an employee with one child in nursery, for the 2024/25 tax year they will need to earn just over £113,500 to make up for the loss of support, but if they have two children it will take them almost £126,500 before they break even. Anything below these figures and they would have been better off without a pay rise above £100,000.

The good news is that pension contributions, either via salary sacrifice or by making personal contributions can be used to reduce an individuals adjusted net income to below £100,000. This has the advantage of not only keeping the childcare subsidies but it also means the parent can use their personal allowance in full.

While some may struggle to empathise with six-figure earners during the cost-of-living crisis, the tax system should operate fairly for all, regardless of income levels. Rather than the current sharp cut-off point, the government could consider phasing out support gradually in the Budget to avoid excessive effective tax rates beyond 100%. The tax system needs fixing properly, not just a temporary patch up, so there isn’t material unfairness to taxpayers at any level.