‘Absurd’ childcare trap puts high earners out of pocket

Arrangement means some parents would be better off if they took a pay cut of £34,000, warns IFS

AN “ABSURD” tax trap caused by Jeremy Hunt’s childcare reforms means that high-earning parents would be better off if they took a £34,000 pay cut.

A parent with two young children earning up to £134,500 will be worse off than one earning £99,000 under the Chancellor’s latest reforms of the childcare system, the Institute for Fiscal Studies (IFS) has warned.

Mr Hunt extended 30 hours a week of free childcare to working parents with toddlers older than nine months in Wednesday’s Budget.

However, free childcare entitlements, as well as access to the tax-free childcare subsidy scheme, are limited to families where neither parent earns £100,000 or more.

If a parent gets a pay rise that tips them over this benchmark, they face a cliff edge for childcare support.

The IFS said: “Families can easily be worse off overall even after a substantial pay rise.” Mr Hunt’s extension of free childcare means that this tax trap has been multiplied. Families are now much more likely to find their free entitlements are at stake for two or more children at a time.

A parent with a one- and three-yearold, whose childcare provider charges the average English rate for 40 hours per week, will effectively lose £14,500 in disposable income if their salary hits £100,000, the IFS calculated.

They would not be better off until their pre-tax pay hit £134,500. This means that a parent earning £130,000 would be worse off than if they earned £99,000, the IFS said.

Robert Joyce, deputy director of the IFS, said: “A presumably-unintended effect of the childcare announcements is to exacerbate one of the most severe distortions you are ever likely to see within a tax and benefit system.”

Those with higher childcare costs face even more extreme distortions under the new reforms.

If the same parent was paying average London childcare rates for 50 hours a week, their disposable income would plunge by £20,000 once their pre-tax earnings hit £100,000. They would not be better off until their pre-tax pay reached £144,500.

Roxy James, 30, has an eight-month old baby and is pregnant.

She wants to return to her job as an infant school teacher after she has had her second child, but will be held back by childcare costs because her husband is a high earner.

She told The Daily Telegraph: “At first, the Budget made me feel really excited to go back to work at my school and have that financial independence. But now I have realised that my husband’s salary puts us just over the threshold.”

Ms James, who asked for her name to be changed, said: “If we are paying nursery fees for two children in London, my state school salary would be wiped out. It just doesn’t make financial sense for me to go back to work.”

Parents have a massive incentive to keep their taxable income below £100,000 before their children start school.

Mr Joyce said: “This is somewhat ironic in a Budget that was so focused on work incentives, though the easiest response to this distortion will typically be to make large pension contributions for short periods when children are young.”

If a London parent was earning £139,000, they would have a higher disposable income if they paid £40,000 per year into their pension pot.

This approach works in tandem with the Chancellor’s move to raise the annual limit on tax-free pension contributions from £40,000 to £60,000.

Even parents who earn £160,000 will have large incentives to use all of this new £60,000 allowance.

The IFS said: “Many of them would effectively be able to buy a £60,000 pension pot while only reducing their current disposable income by a small fraction of that.”

Kiran Vasudeva, partner at JMW Solicitors, warned that other parents will simply cut their working hours so that their income falls below the cut-off.

Ms Vasudeva said: “High earning parents should not feel compelled to reduce their working hours to lower an already significant tax burden.”