Tax-Free Childcare: What it means for your payroll

Working parents make an important contribution to the UK labour force and they can benefit from a number of different government initiatives that help them to cover their childcare costs, including Tax-Free Childcare.

As an employer, Tax-Free Childcare has implications for your payroll, particularly if your employees who are parents choose to switch to the arrangement from the previous childcare voucher scheme.

You are also likely to face questions from employees about the pros and cons of each scheme.

This article looks at the questions that are likely to arise and will equip you with the answers to advise your employees on the different childcare schemes and how they work.

What is Tax-Free Childcare?

Tax-Free Childcare, which is administered by HMRC, is a government initiative that’s intended to support working parents with the cost of childcare.

First introduced in 2017, it’s a replacement for the existing childcare voucher scheme, which closed to new entrants on 4 October 2018.

How does Tax-Free Childcare work?

The HMRC Tax-Free Childcare scheme is based on the principle that for every 80p a working parent puts into a designated online account, the state will add an extra 20p.

Effectively, the scheme is refunding the parent’s basic-rate tax on his or her childcare contribution – which is how the scheme gets its name.

The tax relief is only available on the first £10,000 of childcare costs per child.

With Tax-Free Childcare, working parents can get up to £500 per child from the UK government every three months – up to a maximum of £2,000 per year – to help cover the cost of approved childcare.

Approved childcare includes au pairs, breakfast clubs, childminders, nannies, nurseries and playgroups.

Who is eligible for Tax-Free Childcare?

In order to qualify, a parent must be in work and have a child aged 11 or under who is usually living with them.

If there are two parents in the household, they both must be in work. The parent or parents must also earn at least £125.28 per week and cannot receive any tax credits, Universal Credit or employer-supported childcare such as childcare vouchers.

Parents aren’t eligible to claim Tax-Free Childcare if either partner has a taxable income above £100,000.

What is the childcare voucher scheme?

The childcare voucher scheme is the predecessor arrangement to Tax-Free Childcare. It’s a salary sacrifice scheme offered voluntarily by employers.

With this scheme, parents sacrifice part of their salary in exchange for childcare vouchers of an equal amount in value. The scheme affects payroll because parents who participate in it don’t pay tax or National Insurance on the amount that they sacrifice for childcare vouchers, up to a certain limit.

The vouchers they earn through the scheme can be used to cover the costs of registered childcare providers.

Although the scheme is now closed to new entrants, employers are still able to provide childcare vouchers to employees who were registered before the scheme’s cut-off date of 4 October 2018.

The childcare voucher arrangement operates on a per-employee basis, rather than a per-child basis. So, a working parent who is a basic-rate taxpayer can buy £243 worth of childcare vouchers per month. Between them, two working parents could therefore buy £486 worth of childcare vouchers per month.

Each parent benefits from an annual tax and National Insurance saving of up to £933. Higher-rate taxpayers can spend up to £124 per month each on childcare vouchers and benefit from an annual tax and National Insurance saving of up to £625.

Additional-rate taxpayers can spend £110 per month on childcare vouchers, and benefit from an annual tax and National Insurance saving of up to £623.

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Childcare voucher scheme vs Tax-Free Childcare

Childcare vouchers or Tax-Free Childcare – which scheme offers the greatest benefits to working parents?

If you have employees who already use the childcare voucher arrangement, this is a question you’re likely to be asked. It’s not necessarily an easy question to answer, however, since each option inevitably has its own pros and cons.

• One advantage of Tax-Free Childcare is that it’s open to all qualifying parents, including the self-employed. This is in contrast to childcare vouchers, which are only available to employees who work for an employer that has voluntarily chosen to operate the arrangement.
• Another advantage of Tax-Free Childcare is that grandparents, family members and friends can put cash into the Tax-Free Childcare account to enable the working parent(s) to benefit from the government’s top-up.
• Tax-Free Childcare operates on a per-child basis rather than a per-employee basis, which means it could be a lot more valuable than childcare vouchers for parents with large families.
• One potential disadvantage of the Tax-Free Childcare scheme in comparison with the childcare voucher scheme is that it is limited to parents of children aged 11 or under (or under 17 if children have disabilities). This is lower than the higher age limit of 15 years for the childcare voucher scheme.
• A further disadvantage of Tax-Free Childcare is that it cannot be used by couples where one parent doesn’t work, or doesn’t earn the minimum amount to be eligible. The exception is that if the non-working parent receives a qualifying benefit such as incapacity benefit. Childcare vouchers, however, can be claimed if there is only one working parent in a couple.
• Higher-rate taxpayers who earn more than £100,000 and additional rate taxpayers (who, by definition, earn more than £150,000) are able to participate in the childcare voucher scheme but are not eligible for Tax-Free Childcare.
• The childcare voucher scheme can prove to be the better financial option for parents who have comparatively low childcare costs – less than £470 per month where both parents are eligible for childcare vouchers, or less than £240 per month when one or both parents are eligible.

Where employees already participate in the childcare voucher scheme, they should carefully assess whether it is better for them to stay with that arrangement or to move to Tax-Free Childcare.

Their considerations should include the number of qualifying children in the family, and the number of parents who can buy the vouchers, as well as the amount of tax and National Insurance relief offered by those vouchers.

What does Tax-Free Childcare mean for your business?

In theory, the government’s Tax-Free Childcare scheme reduces the administrative burden on businesses since the arrangement is made directly between the government and the individual.

This is in contrast to the childcare voucher scheme, which is effectively an arrangement between the employer and the employee.

In practice, however, businesses that employ parents are likely to face questions from their employees about the differences between the two schemes while both run concurrently.

The most common question will probably relate to whether an employee who is currently using childcare vouchers should switch to Tax-Free Childcare.

This is no one-size-fits-all answer to this question, however, since it will depend on the individual circumstances of the employee.

“Compared with the childcare voucher scheme, the Tax-Free Childcare arrangement takes away the employer’s compliance responsibilities and associated administration costs,” says Vaneeta Khurana, partner and national head of employment tax at accountancy firm Mazars.

“It does leave the employee with more choices to make on their own, however.”

What does Tax-Free Childcare mean for your payroll?

Employees who currently receive childcare vouchers are obliged to tell you if they have decided to participate in Tax-Free Childcare. They have 90 days in which to do this.

Once you have been notified, your team will need to adjust its payroll accordingly.

If an employee has told you that they have elected to join Tax-Free Childcare scheme, they can’t opt back into the childcare voucher scheme. The employee is still able to use any remaining childcare vouchers after joining Tax-Free Childcare.

Another potential payroll impact of Tax-Free Childcare is that you can choose to pay into an employee’s childcare account on behalf of the employee.

“With this option, the employer makes the payment into the childcare account directly from the employee’s net pay – after tax and National Insurance have been calculated – via the payroll system,” says Vaneeta.

She adds: “Alternatively, employers may choose to make additional payments into childcare accounts without reducing an employee’s net pay.

“In this case, the additional payment made by the employer will be classed as earnings and subject to the appropriate tax and National Insurance deductions.”

Chelsea Connolly, a tax senior at Surrey accountancy firm RJP, says: “Overall, employers are unlikely to have many payroll considerations in relation to employees wishing to move from using childcare vouchers to the Tax-Free Childcare system.

“As childcare vouchers are currently dealt with in line with the payroll and Real Time Information requirements, if an employee wants to swap to the new scheme, it is likely to be as simple as not processing the childcare vouchers for that employee going forward.”

What does Tax-Free Childcare mean for your employees?

Until the childcare voucher scheme was closed to new entrants on 4 October 2018, employees could choose whether to stay in that scheme or participate in the new Tax-Free Childcare scheme.

This choice still exists for employees who continue to participate in an employer-supported childcare voucher scheme.

Employees who became parents after 4 October 2018, or who did not join the childcare voucher scheme by that date, do not have this choice, though. They can only participate in Tax-Free Childcare, provided they are eligible to so.

For employees who are trying to decide whether to stick with the childcare voucher scheme or switch to Tax-Free Childcare, there is a lot to weigh up.

“Employees who are currently on the childcare voucher scheme now have the opportunity to review the benefits and drawbacks of making the switch to the Tax-Free Childcare scheme,” says James Thurlow-Craig, founder of Surrey-based website design and software development company Create Designs.

“This is an important decision that shouldn’t be taken lightly. As a business, we’ve made the decision to provide factual, impartial advice, based on each employee’s current and potential future situation.

“By taking an active approach, we hope to reduce employees’ stress levels, allowing them to make an informed decision.”

How parents can apply for Tax-Free Childcare

So, what is the Tax-Free Childcare sign-up process? To register and create a login, one parent needs to set up an online childcare account through Childcare Choices, which links to the Government Gateway.

Parents who want to pay money into their account, pay their Tax-Free Childcare providers, or apply for Tax-Free Childcare for a new child, can sign in to their account to do so.

Either one or both parents can transfer money into the account. The money from the parents is topped up with extra cash by the government on the same day it is put into the account.

To keep receiving the benefit, parents must reconfirm their eligibility every three months using their Tax-Free Childcare sign-in.

Whenever they log in to their account, parents will need the Government Gateway user ID and password that they used when they originally applied for Tax-Free Childcare.

Other government support options for childcare can be found at Childcare Choices.

Conclusion on Tax-Free Childcare

In theory, the Tax-Free Childcare scheme is more easily accessible to a larger number of working parents than the childcare voucher arrangement.

It’s also arguably a fairer way of providing childcare support to working parents in the UK. Nevertheless, there will be individual winners and losers with both schemes.

So, parents need to weigh up their choices carefully when it comes to deciding how they want to cover their childcare costs – and they are likely to need the support of you, as their employer, to do this.