The tax trap that costs high-earning parents £20,000

High earning parents will lose out on more than £20,000 of childcare support each year under new government changes, data shows.

Fresh measures to support parents of children as young as nine months came into effect on Sept 1 but do not extend to families where the main breadwinner earns more than £100,000.

Experts said the “warped” system puts these parents in an effective tax trap whereby they would be worse off earning £126,000 than if they were on a salary of £99,000.

This month, families can start claiming 15 hours of free childcare each week for children between 9 months and three years under changes brought in by the Conservative government.

To qualify, each parent must earn more than £9,518 per year but less than £100,000. There are no limits on a parents’ combined income so long as neither earns above £100,000 individually.

The measures will be extended again from September 2025 when 30 hours of free childcare will be made available to all under-fives during term-time.

But it puts high-earning families on a “cliff edge” as they already miss out on other support such as the £2,000 tax-free childcare scheme, experts said.

New analysis by investment platform AJ Bell shows a family with one high-earning parent and two children under two will effectively lose out on £20,000 worth of childcare support annually from next academic year.

This is compared to a middle-income family where the main breadwinner earns £60,000 per year. The analysis covers the value of the new free hours scheme, tax-free childcare and child benefit entitlement.

This year, they are already set to lose out on £13,000.

Charlene Young, savings expert at AJ Bell, said: “Whilst many working parents will welcome the latest extension of funded childcare hours, a distortion in the tax system means that the cliff-edge for high earning parents will worsen.”

The thresholds are based on adjusted net income’, which includes income from investments, savings and property as well as earnings. Bonuses are also counted within this.

For example, under the current rules a family with two children aged one and two – where the breadwinner earns £99,000 but gets awarded a bonus of £2,000 – would be classed by the Government as earning an adjusted net income of £101,000.

Ms Young said: “Due to the warped rules, this £2,000 pay rise ends up costing them nearly £10,000, an effective tax rate of almost 500pc.

Their salary would need to increase to £126,624 before they get back to the same disposable income as when they were earning £99,000. This puts parents in the ridiculous place where they are effectively worse off earning between £100,000 and £127,000.”

Once the government-funded hours for under-threes increases to 30, the “cost” of a small bonus will be even more.

Ms Young said families in this position can try to regain this lost childcare support by paying more into their pensions. This is because pension contributions can lower the adjusted net income measure used to test your eligibility for tax-free childcare and enhanced free hours

She added: “If you are the parent in that example, paying in just £800 to a pension would lower your adjusted net income by £1,000. That’s £800 plus automatic basic rate tax relief, which gets you back £11,520 and tops up your pension pot by £1,000 too.

“Paying in £1,600 would recover everything you’d otherwise have lost, plus give you £2,000 extra in your retirement pot.

“That’s because along with tax relief, pension contributions also lower the ‘adjusted net income’ measure used to test your eligibility for tax-free childcare and enhanced free hours.”

A spokesman for the Department for Education said “quality early education” has been unavailable or unaffordable “for too long”.

They added: “It’s often the most disadvantaged families that miss out. Fixing this is a major government priority.

“Through our plans to use primary school classrooms, recruit more staff through a re-energised recruitment campaign and deliver improved early language and maths support, we will build a system that ensures the best start for every child.”

All three and four-year olds are eligible for 15 hours a week of free early education, regardless of their parents’ income. Disadvantaged two-year-olds are also eligible for 15 hours a week of free early education, starting the term after their second birthday.