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Tuesday 18th September 2018

The rush begins to bank tax relief for childcare vouchers before 4 October

The childcare voucher scheme is a tax-free payment for your childcare costs made by your employer. If you enter into an employment salary sacrifice arrangement you'll save tax and national insurance.  In addition, your employer will not have to pay their national insurance contributions on the part you sacrifice.  Some employers pass on some or all of these savings to you.

This scheme is one of several that the government has introduced over the years to reduce the cost of childcare for parents. It began in 1989 but closes to new applicants on Thursday 4 October 2018. If you’ve already joined, then you can continue to use it until your child turns 16 years old.

How to use the scheme

The most common way to use the scheme is for your employer to issue childcare vouchers to you. You can then pay an Ofsted registered childcare provider using these vouchers. If the childcare costs more than the value of the vouchers, you pay the difference with your own money. There are many online voucher providers, and they will charge your employer an administration fee for their services.

Alternatively, your employer can pay the childcare provider direct. Your employer should write a letter to the provider,  asking them to invoice them directly for the childcare and to include the name of the child(ren).

If you’re an employee

You can receive up to £243 per month for childcare as a basic rate tax payer, or £124 for a higher rate tax payer. This can be in addition to salary, but usually as an employee you will “salary sacrifice” – and reduce your salary by the same amount you receive in childcare vouchers.

Making a salary sacrifice as a basic rate tax payer currently saves you £933 for a tax year in income tax and national insurance.  It's also good for your employer as they will save £402 in employer's national insurance.

If you’re a director and shareholder

If you're a company director the terms of the scheme are the same as for employees.  However, if you are a director and shareholder to save on your national insurance costs you will typically pay a low salary and higher dividends and will be less likely to enter into a formal salary sacrifice. 

By making the maximum tax-free payment of £243 per month from your company instead of withdrawing this amount as dividends, as a basic rate dividend tax payer you could save income tax of £218 a year.  Your company will get a tax deduction for the childcare payments, saving corporation tax of £554 a year.

Remember the tax-free allowance is per employment not per child

If your partner/spouse is also in employment they too can qualify for employer funded childcare for the same child.

This is great news if you're a director and have your partner/spouse an employee or director in your company as they too can receive the tax free payments, doubling the tax saving.  If your partner/spouse has a second employment offering childcare the tax saving can be tripled.

Eligibility

Unfortunately, if you’re self-employed, un-employed or your employer doesn't want to provide childcare payments as an option, you can’t use the childcare voucher scheme.

Take action by 4 October 2018 if you’re not in a scheme

The scheme is closing to new entries and by the 4 October 2018, a payment must have been made to the childcare provider (if paying directly), or vouchers must have been paid for. This effectively “reserves” your place in the scheme, to be used as much as you want until your child is 16.

Tax Free Childcare

Childcare Vouchers is the best scheme for tax savings.  The new government scheme is called Tax Free Childcare. Despite the name, this scheme has nothing to do with tax! You don’t need to be paying tax, and you’ll get the government top up as long as you’re working – see Eligibility below. For every £8 you pay in, the government adds £2. You can get up to a maximum of £2,000 per child per year – if you pay in £8,000 then the government pays in £2,000 as £500 every 3 months.

Similar to the vouchers scheme, you can only use this to pay for “approved childcare” – which means the childcare provider must be registered with Ofsted. If the childcare is provided at a school, it must be outside of normal school hours. 

Unlike the vouchers scheme, your child will stop being eligible on 1 September after their 11th birthday.

Eligibility

You and your partner (if you have one) need to be employed or self-employed and earning at least £125.28 per week each if you’re 25 or over. If you’re under 25, you need to earn the equivalent of 16 hours per week on National Minimum Wage.  You will need to apply online to join the scheme - see how to join below.

Free childcare for 3 and 4-year olds

This scheme has been running for some years and gives 15 hours of free childcare for every child, starting from the school term after their 3rd birthday. Since last September, the number of hours has been increased to 30 hours per week. While the original 15 hours are still available to everyone, there are some restrictions on the new additional 15 hours.

As with the Tax-Free Childcare scheme, both parents must be earning at least £125.28 per week each if you’re 25 or over. If you’re under 25, you need to earn the equivalent of 16 hours per week on National Minimum Wage.

For 2 year olds, there is 15 hours of free childcare available when their family receives certain benefits including:

  • Income Support
  • income-based Jobseeker’s Allowance (JSA)
  • income-related Employment and Support Allowance (ESA)
  • Universal Credit - if you and your partner have a combined income from work of less than £15,400 a year after tax
  • tax credits and you have an annual income of under £16,190 before tax
  • the guaranteed element of State Pension Credit
  • support through part 6 of the Immigration and Asylum Act
  • the Working Tax Credit 4-week run on

How to join

You can apply online for

Tax-Free Childcare
30 hours free childcare.

If you don't already have one, you’ll need to set up a Government Gateway account online, as part of the application.

What is a childcare provider?

Any person or organisation that looks after children and is registered with Ofsted can be an approved childcare provider. They can include

  • Nurseries
  • Nannies
  • Au pairs
  • Crèches
  • Childminders
  • After school clubs
  • Extra-curricular activities (such as music lessons)
  • Breakfast and after-school clubs
  • Holiday clubs or schemes (such as the YMCA)
  • Activity holiday companies including Activate Sport, Barracudas, Camp Beaumont and XUK
  • Qualifying childcare offered by schools

Am I better using childcare vouchers or tax-free child care?

There are many important parts to consider when answering this question. It helps to know the following: -

  • how much your child care costs are
  • the hours you and your partner work in a week, 
  • your earnings 

Generally, the Tax-Free Childcare scheme works best for the self-employed and parents with more than one child who have high childcare costs in excess of £9,500.

Generally, the Childcare Vouchers work best where parents work under 16 hours a week and have childcare costs of under £9,500.

You must also remember you can’t be in both schemes, and both parents must be in the same scheme.  You must carefully consider if it’s better for you to join the tax-free childcare scheme before you leave the voucher scheme.  Once you have left the voucher scheme you will not be allowed to re-join.

An example

Paying for childcare using your own company

Darren and Davina are private dentists and have their own company.  Davina has just returned to work now their children are at nursery, and is working 16 hours a week.  Darren works 40 hours a week.  They have childcare costs of £500 a month and pay the nursery direct from their company.  This saves them the administration costs of the vouchers.  

As tax savvy company directors and shareholders, they have a low salary and high dividend.  They work out the £486 their company pays in childcare each month (£243 each) saves their company £92 in corporation tax.  They make a private £14 top up payment to make up the £500 monthly cost. The £14 they extract from their company as a dividend is costing them £4 in income tax and corporation tax.  The net cost of their childcare after tax relief is £412 (500-92+4).

Considering changing to tax free childcare 

The good news is that they can now consider joining the tax-free childcare scheme.  Remember this wasn’t possible until Davina started working 16 hours a week.  They work through the calculations.

Knowing that the government will add 20% to the cost of their childcare when they use the tax-free scheme they work out they only need to pay £400 each month into the scheme.  The government will top up their account with an extra £100 to make up the £500 needed.  They will now need to pay an increased monthly company dividend to themselves by £386 (400-14) to fund their private payment to their tax-free childcare account.  The tax cost of this extra dividend is £102 in income tax and corporation tax.  The net cost of their childcare is now £506 (400+102+4).

Conclusion

Darren and Davina decide not to change to the tax-free scheme as it would increase the cost of their monthly childcare from £412 to £506, an increase of £94 a month.