Pre-school childcare support and the £100,000 limit

The government provides financial support to help parents with childcare costs, and has a particular focus on pre-school children. We cover this support more comprehensively in our article ‘What childcare support does the state provide?’

Pre-school support is offered in hourly rather than monetary terms. The state will currently pay for 30 hours a week of childcare to a two-parent family (or the sole parent in a single parent family) with a child aged between three and four. This applies for 38 weeks a year (during school term time) and averages out at 22 hours a week for a 52-week period.

To be eligible for this support each parent (or the single parent) must be employed or self-employed. To qualify for childcare support they must also earn at least £167 a week and no more than £100,000 a year (including bonuses) (1).

So a family where both parents earn exactly £100,000 would be eligible for the entire 30 hours weekly childcare support. But a family where one of the parents earns £100,001 would not qualify for any of this support at all, even if the other parent earns considerably less. The Institute for Fiscal Studies (IFS) describes this £100,000 cut-off point as a ‘cliff edge’ (2).

The cost of weekly childcare varies according to a range of factors, such as location, the child’s age, and the number of childcare hours required. The National Childbirth Trust (NCT) says the average weekly cost of sending a child under two to nursery for 25 hours a week is £138. This amounts to just over £7,000 a year (3).

Missing out on childcare support

So we can broadly say that, once one of the parents earns more than £100,000 a year, then a family will lose state childcare support worth somewhere around £7,000. But this is on a tax-free basis: someone with taxable earnings of more than £100,000 would have to earn significantly more than £7,000 to compensate for the lost entitlement. In the words of the IFS, this can leave families ‘worse off overall even after a substantial pay rise’.

In his March 2023 budget, chancellor Jeremy Hunt announced an extension of pre-school childcare support in an effort to provide help when both parents or the sole parent want to work (4).

This extension of support for pre-school childcare will take place on a phased basis across 2024 and 2025 (5). By September 2025 working parents of children under the age of five will be entitled to 30 hours of free childcare a week. This includes one and two-year-old children, in addition to three and four year olds.

In the words of the IFS: ‘By extending free entitlements to one and two-year-olds, the government will significantly expand the scope of those cliff-edges, and their size. This is because many more families will now find free entitlements at stake for two or more pre-school children at the same time.’ (2)

Financial impact of the £100,000 cut-off point

The IFS has done some analysis on the potential financial impact of the £100,000 cut-off point. It first considers a parent with two children aged below three, whose childcare provider charges England’s average hourly rate for 40 hours per week. After these reforms, this parent’s disposable income (referring to income after tax and childcare outgoings) falls by £14,500 once their pre-tax pay crosses £100,000. The IFS estimates disposable income would not recover its previous level until pre-tax pay reached £134,500. On this basis, a parent earning £130,000 would be worse off than one earning £99,000.

For those with higher childcare costs the impact is even greater. The IFS estimates that a similar parent paying average London rates for childcare, using 50 hours per week, would see a £20,000 fall in disposable income when their pre-tax earnings cross £100,000. Disposable income would not recover its previous level until pre-tax pay reached £144,500.

Increased pension contributions could reduce your income

As we explain in our Pensions and personal allowance article, people earning more than £100,000 a year are already hit by an effective 60 percent tax rate. This is because HMRC claws back the annual £12,570 tax-free personal allowance for incomes above £100,000, giving rise to an effective tax rate of 60 percent on income of more than £100,000 and up to £125,140.

In the ‘Pensions and personal allowance’ article we suggested that you might consider increasing your pensions contributions if that could enable you to bring your income down to £100,000 or less. The case for doing so could be even stronger in the period when you could be eligible for pre-school childcare entitlements.

The chancellor gave a relatively brief outline of changes to childcare support in his budget speech and it is always possible that the £100,000 limit will be amended in the future. In the meantime, people earning more than £100,000 a year would benefit from a close review of their financial situation, to ensure they are making the most of tax allowances and childcare support.

At Schroders Personal Wealth, one of our principles is to have regular reviews with a financial adviser. This can help ensure you are on track to meet your life goals and that your financial plans keep pace with changes in government legislation.

Sources:

(1) MoneyHelper, ‘Help with childcare costs’, 18 September 2023.

(2) IFS, ‘Childcare reforms create a new branch of the welfare state – but also huge risks to the market’, 15 March 2023.

(3) NCT, ‘Average childcare costs’, 19 September 2023.

(4) Gov.uk, ‘Spring Budget 2023 speech’, 15 March 2023.

(5) Gov.uk, ‘Budget 2023: Everything you need to know about childcare support’, 16 March 2023.