- Some parents are currently better off working less or diverting money toward pensions to reduce their adjusted net income
- Analysis from the Centre for British Progress finds changing the broken system could raise more in new tax revenue than the cost of the extra childcare
- HM Treasury could net between £130 million and £425 million by 2029/30, depending on the extent to which parents change their behaviour
AJ Bell’s senior pensions and savings expert, Charlene Young, comments:
“Earning £100,000 used to be a landmark career moment, but it has become the threshold at which you face eye-watering tax rates and parents lose thousands in childcare support.
“It’s incredibly difficult to defend a policy where some parents will take home less money for working more. The cliff edge has faced universal criticism, even becoming a trending topic on TikTok and other social media sites, so it’s no surprise Education Secretary Bridget Phillipson said she wants to simplify the system in an interview with the FT this week.
“Tinkering with a tax system that is already creaking and adding more complexity is not answer. The simplest solution is to remove the cliff edge altogether and new analysis indicates that it would be a financial win for the government too.
“Although it may not appeal to some backbenchers at first glance, the numbers are compelling. Abolishing the cliff edge could add at least £130 million to the government’s coffers by 2029/30, even after the cost of handing extra childcare benefits to higher earning families is factored in, according to forecasts from the Centre for British Progress. They argue that is a conservative estimate and could end up much higher, especially if the cliff edge were instead replaced with a different tax.
“That boost for the taxman is down to an anticipated windfall in income tax receipts from parents accepting promotions or diverting less into pensions, which would exceed the cost of extending childcare support to high earning families.”
The cliff edge problem
“AJ Bell analysis shows a family with two young children currently loses almost £30,000 in childcare funding if they’re ineligible for child benefit, tax free childcare and the free hours scheme.
“The main breadwinner in a family of two young children aged 9 months and 2 years old would need to see their income increase to around £156,000 before the family got back to the same total disposable income as when they were earning £99,000.
“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’.
Adjusted net income and pension contributions
“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.
“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 by reducing adjusted net income, allowing you to claim childcare funding. In a lot of cases this will leave households in a better financial position today and they also get a pension boost in the process.”
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.
*England. Rules differ in Scotland, Wales and NI.
