How to reduce your childcare costs and build up your pension at the same time!
While there are three main ways in which people are supported by the state when it comes to childcare costs, it can often still seem very expensive. Much of the eligibility for these benefits can be confusing, and often seem unfair. For example, if both partners are working and each earn £99,999 they will be eligible for Tax Free Child Care and also 30 hours free childcare per week. However, in a household where one parent earns nothing and the other £100,001 they wouldn’t be entitled to anything despite having half the household income of the former couple.
The purpose of this blog is to explore the benefits available and then look at the impact income can have on these. Firstly I’ll look at those with income over £50,000 and then those with incomes over £100,000 to demonstrate how you can make best use of a pension contribution to maximise the assistance available from the government.
- An allowance of £20.70 per week for a first child and £13.70 per week for each additional child
- Child Benefit is repaid if either you or your partner have adjusted net income over £50,000. It is repaid at a rate of 1% for every £100 of income over £50,000 and is therefore repaid in full if your adjusted net income is in excess of £60,000.
- This is declared and repaid through your self-assessment tax return.
Tax Free Childcare
- An online account available for each child where the government contributes £2 for every £8 you pay in. You then pay your child care provider directly from the online account. The maximum the government will contribute is £2,000 per annum per child.
- Tax Free Childcare isn’t available where you or your partner have adjusted income over £100,000.
30 Hours Free Childcare
- The government will pay for 30 hours of childcare per week for children between three and four years of age.
- Free childcare isn’t available where either you or your partner have adjusted income over £100,000.
What is adjusted Income?
Adjusted income is your total income less certain allowances including gift aid payments and pension contributions.
So how can a pension contribution help, and what’s the benefit?
If you or your partner earn over £50,000
It is important to note that it is ‘adjusted net income’ over £50,000 rather than just ‘income’. Adjusted net income is your total income less certain reliefs, including gross pension contributions.
So, if someone earns £60,000 and makes no pension contributions, then they would stand to repay their child benefit in full.
However, if someone earned £60,000 and made a pension contribution of £8,000, their adjusted net income would be £50,000 and they would be entitled to retain 100% of their Child Benefit payment.
Let’s look at the mechanics behind this:
An £8,000 pension contribution would receive tax relief at source of £2,000 so the gross pension contribution would £10,000
Adjusted net income is calculated by deducting the gross pension contribution from total income:
£60,000 – £10,000 = £50,000
As a result, and on completion of your self-assessment tax return, you would have no high-income Child Benefit Tax Charge so would retain £1,076 per annum for your first child and £712 per annum for each additional child you have.
In addition to this, the pension contribution will attract higher rate tax relief so you would receive a reduction in your tax liability in the year of £2,000.
In summary, the £8,000 pension contributed has:
1. Boosted your pension pot by £10,000.
2. Saved you £1,076 in child benefit repayments (more if multiple children).
3. Reduced your income tax liability by £2,000.
Therefore, the total return on your pension contribution is at least 63.45% and greater if you’ve got multiple children.
If you or your partner earn over £100,000
Assume here that either you or your partner has a total income of £125,000 per annum. Not only are you ineligible for any support towards your childcare costs, you also lose your personal allowance, effectively £12,500 of income which you can earn tax free. This is reduced at a rate of £1 for every £2 of adjusted income over £100,000.
Let’s see what happens if we made a contribution to our pension of £20,000:
Firstly, you would receive £5,000 of tax relief directly from your pension provider, so your gross pension contribution is £25,000.
This means that your adjusted net income is £100,000, so you are now fully entitled to open a tax-free childcare savings account, worth up to £2,000 per annum and also eligible for 30 hours free childcare – this could vary depending on the cost of your child care but let’s say £6,000 per annum for arguments sake.
You would receive a reduction in your income tax liability of £5,000 equivalent to higher rate tax relief via your self-assessment tax return.
You would also be eligible to reclaim your personal allowance, so this is a further income tax saving of £5,000.
Let’s tot that all up:
You pay £20,000 in to a pension
£5,000 of tax relief invested in to your pension
up to £2,000 tax free childcare
up to £6,000 free childcare
£5,000 reduction in our tax bill for higher rate tax relief on the pension contribution
£5,000 reduction in in our tax bill by being entitled to a full personal allowance
So, the total return on your £20,000 pension contribution could be up to £23,000!
In summary dependent on your income levels, there is plenty of scope to plan your finances to ensure you are maximising the government funding available to assist with your family’s finances. Obviously having the disposable income available to fund the pensions is often a barrier to investment, but hopefully as I’ve demonstrated in the examples above you can actually end up better off in the short term, while also building up assets in your pension for the future.
The information contained within this blog is subject to the UK regulatory regime and Tax system and is therefore targeted at consumers based in the UK.
The information and examples are provided for guidance only and no responsibility can be accepted by ourselves or our representatives. The information provided does not constitute advice and should not be acted upon without taking professional advice.