Tax-free childcare: How does it work?

The government’s new tax-free childcare scheme was finally launched this April – after a legal challenge resulting in a delay of over a year.

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Who is it for?

Initially the government’s tax-free childcare scheme will only apply to parents with a child aged under four on 31 August 2017. However, as soon as one child becomes eligible it may be possible to use the scheme for other children. The scheme will be rolled out throughout 2017 for other parents who can sign up now for an email alert at www.childcarechoices.gov.uk . Tax-free childcare is available for working parents with children aged under 12 (or under 17 if they are disabled). For every £8 the parent pays in, the government will automatically add a further £2, so parents effectively get basic rate tax relief for childcare costs. Parents can use the scheme to pay for up to £10,000 of annual childcare costs for each child, potentially saving some £2,000 – and the amounts are doubled for disabled children. If your childcare costs come to more than £10,000, the first £10,000 benefits from tax relief, and you will have to bear the full cost of additional payments.

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Setting up an account

The tax-free childcare account must be set up online and can then be used for one-off payments or regular savings. Employers, grandparents, friends or other people can also pay into the account, which can be used to pay for childcare such as nurseries, nannies, childminders and out-of-hours school clubs. Crucially, the childcare provider must also be signed up with the tax-free childcare scheme.

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Who qualifies?

Both parents need to be working, with average earnings equal to at least 16 hours at the national minimum/living wage – £120 a week if they are aged 25 or over – although there are certain exceptions to this. Parents are not eligible for tax-free childcare if either partner expects to earn £100,000 or more a year. Free childcare provision differs across England, Scotland, Wales and Northern Ireland. Tax-free childcare cannot be used at the same time as childcare vouchers from an employer, so you may need to choose between the two schemes. A parent can still join an employer’s childcare voucher scheme up to April 2018, and once a member they will be able to continue for as long as the scheme is available or until they change jobs. Parents should obviously remain in a voucher scheme, even if they don’t qualify for tax-free childcare, for example because only one parent works or their earnings are not sufficient or they exceed £100,000. The voucher scheme is available for children aged up to 15, not just up to age 12.

Tax-free childcare is very helpful for the self-employed, who cannot benefit from childcare vouchers, and others whose employer does not offer them.

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Scheme suitability

The help available under the tax-free childcare scheme increases with the number of children, unlike the position with childcare vouchers. So opting for tax-free childcare should be beneficial if you have more than one child and high childcare costs. For other parents, the decision is more complicated and will depend on their tax position and the level of childcare costs. For example, the maximum tax relief available under the childcare voucher scheme is £933 if it is available to just one parent who is taxed at the basic rate. Childcare costs would need to exceed £4,665 before tax-free childcare resulted in more relief – double that if vouchers were available to both parents. Parents who switch from childcare vouchers to tax-free childcare should make sure they can either receive a refund for unused vouchers (which is often not possible) or they can use them up.

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