This month and with little fanfare, the Government broadened the free childcare entitlement for parents, unlocking a potential saving of £7,500 a year! (1)
Parents with children who turn nine months old before 1 September can now apply for 30 hours per week of free childcare until their child starts school. For those with children aged nine months to two years, the current eligibility for 15 hours will increase to 30 hours from September, making this benefit even more valuable.
However, some parents may miss out on this benefit due to being over the maximum net adjusted income level of £100,000. But don’t worry, there are ways to qualify while also boosting your retirement savings. According to the government website, there are just under a million people in the UK who earn between £75,300 and £96,400, most of whom are over age 35. With income tax bands frozen until 2028, many in this category are expected to breach the cap through salary increases or bonuses, automatically losing the entitlement.
Typically, extra salary is viewed as a positive, but there’s a peculiar situation for individuals earning £100,000 or less, where earning more could paradoxically result in financial loss.
Meet Anna
Anna is 40 and recently returned to work following the birth of her second child last year. She works in IT and has a basic salary of £95,000, making her eligible for 60 hours of free childcare and tax-free childcare from September. After recently completing a project, Anna is delighted to find out she is to be paid a bonus of £25,000, which will be a massive help to the family finances. However, by receiving the bonus, Anna will actually be worse off, as the government system means that anyone who earns in excess of £100,000 loses not only the free childcare entitlement (30 hours per child) but also the £2,000 allowance per child for tax-free childcare.
| 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 (2) | (£30,992) | (£30,992) |
| Free childcare for two children under age 3 | £13,588 | £0 |
| Tax-free childcare | £4,000 | £0 |
| Residual net income | £52,254 | £45,166 |
Source: Equilibrium Financial Planning
Shockingly, by receiving the bonus, Anna is £7,088 worse off in her pocket! But there’s a solution that can ensure the bonus doesn’t cost you a penny and you keep all your childcare entitlements, while also planning for the future.
If Anna’s employer had made a £25,000 contribution to her pension instead of paying her the bonus, the result could be significant. As the pension contribution was made as salary sacrifice, the employer rebated the national insurance savings of 15% to Anna, giving a gross pension contribution of £28,450. The immediate benefit is that Anna would no longer fall foul of the £100,000 threshold, as this is based on income minus pension contributions.
Anna is planning to retire in 25 years, so she’s happy to take a reasonable level of risk with the pension contribution and invest in a basket of global equities with an 8% per annum target return. Astonishingly, if the target growth level is achieved, the £25,000 bonus payment could be worth £208,828 or more, of which 25% can be taken tax-free (based on current pension rules)!
Knowledge is power
By having the knowledge and foresight to protect childcare allowances and fusing them with pension planning, we can help not only plan for today but also for the future, ensuring more is most definitely more!
Investments will fall as well as rise. This article is intended as an information piece and should not be construed as advice.
Concerned about how you or your loved ones might be missing out on childcare allowances? Call us today on 0161 486 2250 or reach out to your usual Equilibrium contact and we can help to maximise your entitlements.
New to Equilibrium? Call 0161 383 3335 for a free, no-obligation chat or contact us here.
Sources
(1) Gov.uk
(2) Based on the hourly rate in the Coram Childcare report
