- September sees final phase of free hours childcare scheme extension
- Parents lose access to the scheme once they earn over £100,000
- AJ Bell analysis shows a family with two children could lose almost £30,000 in childcare funding if they’re ineligible for child benefit, tax free childcare and the free hours scheme
- Parents penalised for earning over the £100,000 threshold could be better off reducing take-home pay
- How pension contributions could help beat the tax trap
AJ Bell’s senior pensions and savings expert, Charlene Young, comments:
“September marks the final phase in the extension of free funded childcare hours in England, which could save eligible working parents thousands of pounds a year. But the long standing £100,000 tax trap could mean this punishes higher earning parents even further.
“Parents might be able to re-arrange their finances to side-step the penalty by making modest pension contributions. This can improve their overall financial position as they regain lost childcare support and boost their retirement pots.
“It all comes down to something the taxman calls ‘adjusted net income’.
How income affects access to childcare support
“Families trying to work out how their earnings might impact access to childcare subsidies and child benefit should start by working out their individual ‘adjusted net incomes’.
“Despite the name, ‘adjusted net income’ refers to all income that would be subject to tax, less certain reliefs. So not just earnings, but income from investments, savings and property too.
“If a parent has adjusted net income of over £100,000 for a tax year, then their family will lose the following childcare offers*:
- all entitlement to tax-free childcare, worth up to £2,000 per child per year
- all of the 30 hours funded term time childcare for 9-month to 3-year-old children
- half of the 30 hours for children aged between three and four.
“Parents over the earnings limit will only be entitled to the universal 15 funded hours in term time for three and four year olds.
“As well as losing access to childcare subsidy schemes, their tax-free personal allowance starts to reduce too, meaning even more of their income is subject to tax.
“They will also not be entitled to child benefit, which under the High Income Child Benefit Charge (HICBC) is removed entirely once one partner earns £80,000.
*In England only. Rules differ in Scotland, Wales and NI.
How much high earners miss out on
“There are three key child support payments that parents can obtain: tax free childcare; the free hours childcare scheme; and child benefit.
“While most working couples can access all three, the highest earners are ineligible for almost everything.
“Once one partner earns over £100,000 families are no longer eligible for tax free childcare, worth up to £2,000 per child.
“Likewise, they can’t use the ‘free’ hours childcare funding which will be increased in September to 30 hours per week in term time for children from 9 months up to three years old. Their access to funding for children aged three to four is slashed from 30 to 15 hours as well.
“Child benefit is also off limits for anyone earning over £80,000 – and if you do claim the money, you’ll need to repay it thanks to the HICBC.
“In total, a family with two children aged 9 months and 2 years old could miss out on over £29,000 this coming academic year.
“In contrast, moderately well-off families where the main breadwinner earns £60,000 could access all this support, with the figures illustrating how middle-income families have benefitted hugely from government reforms to child benefit and free hours childcare funding in the last couple of years, while the highest earners continue to be excluded.
“The UK tax system operates primarily on individual earnings, not household income. It means these benefits are not available to a family with one partner earning just over £100,000 and another on £20,000, whereas if mum and dad make £60,000 each they get the full package of support, giving them a higher family spending power.
“Although the previous government hoped to reform the HICBC to base it upon household income, last year’s Budget dismissed the idea. The government said the reforms would eventually cost £1.4 billion if the threshold were increased to £120,000-£160,000 per household, rather than the current system of £60,000-£80,000 based on individual earnings.
Source: AJ Bell. Assumes a family where both parents work and the main breadwinner earns £60,000. Children aged 9 months and 2 years old at the start of each academic year. Based on the national average local authority funding rates for 2024/25 and 2025/26.
Child benefit thresholds increased from 6 April 2024.
How a £2,000 pay rise could cost you over £27,000
“The perfect way to illustrate the ‘cliff-edge’ nature of UK childcare funding schemes is to imagine a parent in this scenario with earnings of £99,000. If they were awarded a bonus of £2,000, bringing their total adjusted net income to £101,000, the warped rules mean this £2,000 pay rise ends up costing them over £27,000 thanks to a combination of taxes (see below) and the loss of childcare subsidies. That’s an effective penalty of well over 1000% on that extra money.
Source: AJ Bell. Family where both parents work and main breadwinner earns £101,000. Two children, one qualifying for under two entitlement and other for two-year-old entitlement, based on national average funding rates.
Background
Income tax and loss of personal allowance
Parents will usually pay 40% income tax – known as the ‘higher’ rate – on the band of earnings between £50,271 and £125,140.
But they also lose £1 of the personal allowance for every £2 of adjusted net income above £100,000. The personal allowance would be lost completely once earnings reach £125,140. This means there is a higher effective tax rate of 60% on earnings of £100,000-£125,140, before any loss of childcare benefits is considered.
Free childcare hours
Eligible working parents of nine-month to four-year-olds can register now to claim up to 30 hours a week of funded ‘free’ childcare from 1 September.
To be eligible both parents must be working and earning at least £10,158 a year. However, parents of under threes lose all their free hours entitlement when either of them earns more than £100,000 (minus any pension and gift aid contributions). For parents of three and four-year-olds the free hours entitlement drops from 30 hours a week to 15 hours a week once either parent earns more than £100,000.
Tax-free childcare
Using a Tax-Free Childcare account, parents can obtain a £2 government top-up for every £8 paid in for under 11s. The government payment is equivalent to basic rate tax relief and capped at a maximum £2,000 per year per child, or £4,000 for disabled children.
The eligibility rules are the same as for the enhanced free hours entitlement, although all tax-free childcare will be lost if either parent earns over £100,000.
Child benefit
Child benefit is paid weekly to eligible claimants at a rate of £26.05 for the first child in 2025/26 (see table).
Under the High Income Child Benefit Charge, some families must repay some or all child benefit received.
The system was reformed from April 2024 so that those with earnings over £60,000 lose 1% for every £200 earned. It means that households with someone earning £70,000 lose 50% of their entitlement, while the benefit is extinguished completely at £80,000. In the 2023/24 tax year child benefit was effectively withdrawn at a rate of 1% for each £100 of earnings over £50,000. It means someone earning £55,000 lost 50% of their child benefit entitlement, while those earning £60,000 lost it entirely.
The charge is always dependent on the earnings of the main breadwinner, not on the combined household income. Some families may choose not to claim child benefit, although this may mean the child is not automatically awarded an NI number at 16.
Claiming child benefit can also mean a parent not working can maintain their NI record, potentially impacting their state pension entitlement.
