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Tax-Free Childcare: winners and losers

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News & Publications: Tax-Free Childcare

The new Tax-Free Childcare scheme will provide eligible parents with childcare support worth up to £2,000. Originally set to be launched this Autumn, the Government has now confirmed that the scheme will be available from 2017. While an estimated two million households will qualify for the scheme, parents who are entitled to Employer-Supported Childcare will need to assess whether they will be better off under the new system.

Tax-Free Childcare

Under the new scheme, eligible parents will be required to open an online account, into which they can contribute money to pay for childcare. The Government will then 'top up' payments at a rate of 20p for every 80p that families pay into the account, which will be capped at £2,000 (£4,000 where the child is disabled).

A child will qualify for the scheme until the first week in September following their eleventh birthday or, for disabled children, until the first week in September following their sixteenth birthday. To be eligible for Tax-Free Childcare all parents in the household must:

  • meet a minimum income level based on working eight hours per week at the National Minimum Wage
  • each earn less than £150,000 a year, and
  • not already be receiving support through Tax Credits or Universal Credit.

Unlike Employer-Supported Childcare, self-employed parents will also be eligible to participate.

Employer-Supported Childcare (ESC)

ESC such as childcare vouchers may be offered in addition to employees' pay or as a reduction in pay (commonly known as salary sacrifice). Under salary sacrifice the employee gives up pay, which is taxable and NIC-able, in return for childcare vouchers, which may not be. This may also save national insurance contributions for the employer.

Parents can receive up to a maximum of £55 a week, or £243 a month, in childcare vouchers, although the exact amount will depend on how much they earn, when they joined the scheme and whether the child is disabled. Vouchers are available per parent, so two working parents paying basic rate tax could be entitled to £486 of vouchers each month.

However, it is important to note that a salary sacrifice arrangement may affect entitlement to certain benefits.

The current system of ESC is expected to be closed to new entrants once the new Tax-Free Childcare scheme is available. However, ESC will continue to be available for current members if they do not wish to switch to the new scheme.

Tax-Free Childcare vs childcare vouchers

While Tax-Free Childcare will be open to more people, individual circumstances will dictate whether parents will be better off under the new system or the existing childcare voucher scheme.

Potential winners of Tax-Free Childcare...

  • Working single parents with annual childcare costs in excess of around £5,000
  • Families where both parents work, and have annual childcare costs in excess of around £9,500
  • Self-employed parents, if they fulfil eligibility requirements.

…and losers under the scheme:

  • Two parent families where one parent does not work – they will not be eligible
  • Employers – they will no longer benefit from lower national insurance contributions
  • Families where either parent earns in excess of £150,000 a year – they will not be eligible.

As a general rule, two parent families with one child where both work are likely to be financially better off under the existing system, but HM Revenue & Customs (HMRC) is expected to publish guidance to parents on this matter in due course.

We can advise on a range of personal tax planning issues, so please contact us for assistance.