- September extension of ‘free’ hours funding not available to the highest earners, exacerbating tax trap on salaries over £100,000
- AJ Bell analysis shows how a family with two children could miss out on a combined £20,000 of child support
- Higher earners face a ‘cliff edge’ where tax free childcare and free hours funding are withdrawn
- April’s changes to child benefit mean more families receive support, but eligibility is still limited to those with up to £80,000 of earnings
- Higher earners also start to lose their tax-free personal allowance, landing some parents with an effective tax rate of 500% on earnings over £100,000
- Paying in just £800 to a pension can help high earning parents reclaim £11,330 in tax and lost childcare benefits
“Whilst many working parents will welcome the latest extension of funded childcare hours, a distortion in the tax system means that the cliff-edge for high earning parents will worsen,” says AJ Bell pensions and savings expert, Charlene Young.
“Parents with high salaries should sit down and work out the numbers to see if they can re-arrange their finances to boost their overall financial position and side-step the tax system’s most egregious penalties on high earners.
“By making modest pension contributions this group can regain lost childcare support whilst boosting their retirement pots, and in many cases boost their net spending power.
“It all comes down to something the taxman calls ‘adjusted net income’.”
How earnings affect access to child benefit and childcare funding
“For families trying to work out how their earnings might impact access to childcare subsidies and child benefit, the first thing to work out is something called your ‘adjusted net income’.
“Despite the name, it refers to all income that would be subject to tax. 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 year, then they’ll lose the following childcare offers*:
- all entitlement to tax-free childcare, worth up to £2,000 per child
- all the current 15 funded childcare hours on offer for nine month to three year olds
- half of the 30 hours for children aged between three and four.
“As well as losing access to those childcare subsidy schemes, their tax-free personal allowance starts to reduce too.
“Parents over the earnings limit will only be entitled to the universal 15 funded hours in term time for three and four year olds.
*England and Wales. Rules differ in Scotland 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 extended this month to 15 hours for children from 9 months old. Their access to funding for children aged 3 to 4 is slashed from 30 to 15 hours.
“Finally, while eligibility for child benefit has been extended from April this year, it is still off limits for anyone earning over £80,000 – and if you do claim you’ll need to repay it thanks to the High Income Child Benefit Charge (HICBC).
“In total, families with two children aged 9 months and 2 years old could miss out on nearly £13,000 this academic year, rising to £20,000 of additional support by September 2025.
“In contrast, moderately well-off families where the main breadwinner earns £60,000 could access all of 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, but the highest earners are 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.
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 as at the start of each academic year. Sept 2023 figures factor in 50% entitlement to child benefit, accounting for the April 2024 changes to HICBC. Value of free hours based on UK average hourly childcare prices in Coram childcare survey 2024, uprated by 2% for 2025.
The £100,000 cliff edge
“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 nearly £10,000 and an effective tax rate of almost 500% thanks to a combination of taxes (see below) and the loss of childcare subsidies.
“What’s astonishing is how much their salary would need to increase to get to the same post-tax income and value of childcare support as before. Their salary would need to increase to £126,624 before they get back to the same disposable income as when they were earning £99,000. This puts parents in the ridiculous place where they are effectively worse off earning between £100,000 and £127,000.
Tax on earnings over £100,000
“For high earning parents, the story isn’t just about the loss of childcare support. They’re also subject to the highest effective tax rate in the UK, thanks to the loss of their personal allowance.
“Those with salaries up to £125,140 are theoretically taxed at a marginal income tax rate of 40%. But that doesn’t paint the full picture. In fact, the withdrawal of the personal allowance means an effective tax rate of 60% on earnings between £100,000 and £125,140.
“That’s because of the loss of the personal allowance, which is cut by £1 for every £2 of earnings over £100,000. It means there’s a strong tax incentive to reduce earnings below £100,000 anyway, with parents facing the double-whammy of lost childcare funding on top.
How pension contributions can help
“Thankfully, there are options for avoiding such a ludicrous penalty on earnings. Diverting money into your pension could leave you in a better overall financial position.
“If you are the high earning parent in our example, paying in just £800 to a pension would lower your adjusted net income by £1,000 (£800 plus automatic basic rate tax relief), gets you back £11,330, and tops up your pension pot by £1,000, too. Paying in £1,600 would recover everything you’d otherwise have lost, plus give you £2,000 extra in your retirement pot.
“That’s because along with tax relief, pension contributions also lower the ‘adjusted net income’ measure used to test your eligibility for tax-free childcare and enhanced free hours. It’s also the point at which you’ll start to lose your tax-free personal allowance at a rate of £1 for every £2 of income above £100,000.
“If you’re able to pay more into a pension, you’ll come further away from the edge and have the benefit of boosting your pension pot at a cost of 60p to you for every extra £1 invested.”
Source: AJ Bell. Family where both parents work and main breadwinner earns £101,000. Two children aged 9 months and 2 years.
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
Working parents of three and four-year-olds can claim up to 30 hours a week of free childcare, with parents of nine month up to three-year-olds currently able to claim up to 15 hours a week.
To be eligible both parents must be working and earning at least £183 a week each. However, parents of two-year-olds lose all their free hour 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.
In September 2025 the free hours entitlement for ‘working parents’ will increase to 30 hours a week across the board. This won’t include those earning over £100,000 though – the rules are written so that they will only remain eligible for 15 hours for children age three and four, despite also working.
- Tax-free childcare
Using a Tax-Free Childcare account, parents can obtain a £2 government top-up for every £8 paid in. 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.
Until October 2018, parents could enroll into a childcare voucher scheme, which worked in a similar way to a salary sacrifice scheme but crucially had no maximum earnings limit. Parents can continue in an existing scheme if they stay with the same employer.
- Child benefit
Child benefit is paid weekly to eligible claimants at a rate of £25.60 for the first child in 2024/25 (see table).
Under the High Income Child Benefit Charge, some families must repay some or all child benefit received.
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.
From 2024/25 the system has been reformed 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.
The charge is always dependent on the earnings of the main breadwinner, not on the combined household income. The previous government indicated a desire to transition to a system based on combined earnings.
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.
