“Less is more” a famous quote by Ludwig Mies van der Rohe, encapsulates the essence of minimalism in design and architecture. Many agree with the concept in design as it is subjective but amazingly this can also be the case when it comes to the government’s help with childcare!
Based on the gov.uk website, there are just under a million people in the UK who earn between £75,300 to £96,400, most of which are aged over 35.(1)
Certainly, for many people, this would be viewed as a substantial income. However, it’s interesting to note that our peak earning years often coincide with the period when raising children is most costly. With the average family size hovering around two children, a lot of us can empathise with the financial struggles that come with the early years of parenting.
Fortunately, the government acknowledges the financial challenges that parents face and has put measures in place to support them. Working parents can benefit from free childcare, with families of children aged 9-months to 2-years old eligible for 15 hours per week. For those with children aged 3-4 years old, they can receive 30 hours each week. Additionally, you could receive up to £2,000 per year per child in tax-free childcare, where the government contributes £2 for every £8 paid by the parents (subject to eligibility and certain income criteria). Undoubtedly, these initiatives have significantly aided parents in achieving financial security, whilst also positively impacting the economy by boosting workforce participation. A joint study by PwC and the Salvation Army(2) in 2017 revealed that the increase in state-funded childcare support that year contributed an estimated £22.3 billion to the UK economy and led to a rise of 286,000 individuals in the labour force.
That being said, for those earning £100,000 or less, there is a peculiar circumstance in which earning more could, ironically, cause financial loss.
Meet Anna
Anna is 40 and recently returned to work following the birth of her second child last year. Anna works in IT and has a basic salary of £95,000 which makes her eligible for 45 hours free childcare and also tax-free childcare.
Table one: Comparison table of Anna’s childcare costs with and without a company bonus
| Without bonus | With bonus | |
|---|---|---|
| Gross income | £95,000 | £95,000 |
| Bonus | £0 | £25,000 |
| Tax | (£25,432) | (£39,432) |
| NI | (£3,910) | (£4,410) |
| Net income | £65,658 | £76,158 |
| *Cost of childcare for two children(3) | (£40,404) | (£40,404) |
| **Free childcare for two children aged 1 and 3 | £13,288 | £0 |
| Tax-free childcare | £4,000 | £0 |
| Residual net income | £42,541 | £35,754 |
Source: Equilibrium Financial Planning
*Equates to £7.77 per hour for 50 hours a week for each child and paid for 52 weeks.
** Equates to £7.77 per hour for 45 hours a week and paid for 38 weeks.
Several months later following the completion of a project, Anna is delighted to find out she will receive a bonus of £25,000 which will be a massive help to the family finances.
However, Anna will actually be in a worse position as a result of the bonus because the current government system creates a cliff edge where anyone who earns over £100,000 loses access to these two lucrative forms of childcare support and some, or all, of their tax-free personal allowance
As detailed above, by receiving the bonus, Anna is £6,787 worse off in terms of net income!
What if I told you that there is a solution for anyone who faces this predicament which ensures that a bonus doesn’t cost you a penny, and also helps towards a plan for your future?
Consider this…
If Anna’s employer made a £25,000 contribution to her pension instead of paying her the bonus, the outcome could be exceptionally better.
The contribution is made via salary sacrifice, and her employer rebates the national insurance savings of 13.8% to Anna resulting in a gross pension contribution of £28,450. The immediate benefit is that Anna no longer falls foul of the £100,000 threshold as this is based on income minus pension contributions.
The longer-term benefit is the potential boost in her retirement pot. If Anna plans to retire in, say, 25 years (at age 65), she may feel comfortable to take a reasonable level of risk with this contribution. Let’s say she invests this in our Equilibrium Global Equity fund, which has a target return of 8% per annum.
Astonishingly, the £25,000 bonus payment (which results in a gross pension contribution of £28,450) could be worth as much as £208,828 of which £52,207 could be taken tax-free (under 2024/25 legislation), should the target growth level be achieved.
Knowledge is power
Instead of Anna accepting a bonus which would make her financial situation worse, she not only keeps her childcare benefits and net income position, but she also significantly boosts her pension fund for the future!
By having the knowledge and foresight to protect the childcare allowances and fusing them with pension planning, we can help plan not only for today, but also for the future and ensure that more is most definitely more!
If you’re caught in the childcare tax trap, please get in touch as we are here to help. Clients can reach us on 0161 486 2250 or by getting in touch with your usual Equilibrium contact.
If you are new to Equilibrium and would like to speak with one of our experts, contact us here or call us on 0161 383 3335 for a free, no-obligation initial chat.
This article was featured in the autumn 2024 edition of our financial planning and investment magazine, Equinox. To download your free copy, click here.
Investments will fall as well as rise. This article is intended as an information piece and should not be construed as investment advice.
Sources
(1) www.gov.uk
(2) www.statista.com
(3) Based on hourly rate in Coram Childcare report
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