How pensions can help with childcare

The subject of childcare has been a hot topic of late. As part of the Chancellor’s plan to get more people into work, plans were announced in the Budget to significantly increase the number of free childcare hours for working parents.

Pensions and childcare aren’t usually discussed in tandem, but there are scenarios in which investing in pensions can have a big impact on childcare costs.

Looking first at free childcare hours. In England all 3 and 4-year-olds currently get 15 hours per week during termtime, regardless of their parents’ circumstances. The free hours for this age group go up to 30 hours if both parents are working (or the single parent works) with certain minimum earnings. However, the extra hours are lost if either parent has adjusted net income (which includes both earned and investment income) of more than £100,000.

You probably know about the effective 60% tax rate on income between £100,000 and £125,140 due to the loss of the personal allowance. But for parents of 3 and 4-year-olds it is much higher. Unlike losing the personal allowance, the loss of childcare is not a gradual reduction, but rather a cliff edge. Earning £1 over £100,000 costs 15 hours of childcare – which at the average rate in England is worth over £3,000*.

What’s more, with the planned increased in provision, there may be even more to lose. Whilst the finer details of the extended hours have not been announced, the plan is for children of working parents to get 30 hours/week from 9 months old by September 2025. The most common age gap between siblings is 2-3 years, so even without twins there will be many families who have two children who can benefit from the new 30 hours. Conversely, these parents will stand to lose even more if their income tips over £100,000 – potentially 45 hours/week (assuming one child aged 3 or 4 keeps the basic 15 hours) – a cost likely to be around £9,400/year* on average.

On top of all this there is the tax-free childcare scheme. With this parents can pay up to £8,000 a year (paid as a maximum of £2,000/quarter) into an online childcare account and receive £2,000 (£500/quarter) from the Government to pay childcare costs, per child. However, like the extra free hours, this also disappears in one hit once income tips over the £100,000 mark.

So let’s take a family with a 1 and 3-year-old, where the highest earner has £100,000 income. If they get a £5,000 pay rise, currently they would lose 15 hours childcare (worth over £3,000), £4,000 tax-free childcare top up, plus £2,500 of personal allowance meaning the additional Income Tax on the £5,000 is £3,000. So, in total the £5,000 pay rise has cost over £10,000. From September 2025 the value of lost childcare hours (45 hours) could go up to c£9,400 to give a total cost of around £16,400. An effective rate of 328% tax.

So where do pensions come into this? The good news is that adjusted net income is reduced by the amount of any pension contributions, so for clients with young children whose income is about to tip over the £100,000, making a contribution is a no-brainer.

In the above scenario, the first option would be to ask if the employer can make additional contributions instead of a salary rise, but if not a personal contribution could be used to bring income below £100,000. This would mean the parent gets to keep not only their whole personal allowance but also all their free hours and top-ups.

Until the children reach school age it may be especially worthwhile to prioritise pensions over salary.

*childcare costs based on figures from Coram Family and Childcare Trust Childcare Survey 2022