However, the Tax-free Childcare Scheme will not be introduced until autumn 2015 and both parents must be working to be eligible.
In the first phase, the offer will be open to around 1.3m families, where both parents are working and do not already receive support through tax credits, or Universal Credit, when this is introduced. They will receive 20 per cent of their annual childcare costs, up to £6,000 a year. The scheme will eventually be extended to all children under 12.
It will also be open to high earners - both parents will be eligible as long as they earn less than £150,000 a year each.
The announcement puts to rest mounting speculation that the Government was planning to axe childcare vouchers and replace them with tax breaks.
As it is, voucher companies will have their role and workload extended on a huge scale.
Currently only five per cent of employers offer childcare vouchers, (known as Employer Supported Childcare), which are used by 450,000 families.
The new scheme will be phased in from autumn 2015 and will be partly funded by phasing out ESC.
When Tax-free Childcare is introduced parents who already use childcare vouchers will be able to stay with their current voucher provider, and the tax exemption for workplace nurseries will continue, where it is offered by employers.
Prior to the start of Tax-free Childcare, eligible parents will continue to be able to join existing childcare voucher schemes. Once the scheme is introduced families using Employer Supported Childcare will be able to choose to move into the new Tax-free Childcare scheme, but will not be eligible for both schemes.
Details of how the new system will operate will be set out following consultation, but it is likely that parents will access the scheme by opening an online voucher account with a voucher provider and will have their payments topped up by the Government.
Self-employed parents will also be eligible for the first time.
For families who receive childcare support through tax credits, an extra £200m will be provided through Universal Credit, which is equivalent to 85 per cent of childcare costs for households qualifying for it, where the lone parent or both parents pay income tax. This will be phased in from April 2016 as childcare support moves from tax credits into Universal Credit and will be funded from social security budgets at the time.
The consultation to take place soon will look at how to provide this support for parents who do not receive Universal Credit to ensure that the two schemes work effectively together.
The Government says that Tax-free Childcare will eventually be open to around 2.5 million families with children under 12 and that it will be worth more than double a single claim for childcare vouchers. It will be open to around five times as many families.
David Cameron said, ‘If Britain is going to succeed in the global race we must help those who work hard and want to get on.
‘Too many families find paying for childcare tough and are often stopped from working the hours they’d like. That is why we are introducing tax free-childcare, saving a typical family with two children up to £2,400 a year.
"This is a boost direct to the pockets of hard-working families in what will be one of the biggest measures ever introduced to help parents with childcare costs.’
Nick Clegg said, ‘Delivering tax-free childcare is the next step to ensuring all families can work and get on. The rising cost of childcare is one of the biggest challenges parents face and it means many mums and dads simply can’t afford to work. This not only hurts them financially, but is bad for the economy too. This announcement of a £1bn investment in childcare will make sure it pays to work.
‘An extra £1,200 for each child will make a real difference to families who find themselves constantly worrying about how to juggle their family budget. And extending support for working families on Universal Credit will make sure it is worth working extra hours even if you're on low wages.’
The Childcare Voucher Providers Association, which has been lobbying the Government to expand childcare vouchers, said it welcomed the plans.
Julian Foster, from the CVPA, said, ‘We have been calling on Government for some time to extend the current childcare voucher scheme and much of what has been announced today will be beneficial to working families. New funding in a difficult economic time is a sign of the Government’s commitment to helping working parents find affordable childcare. In particular we are delighted that this greatly-valued source of support will be extended to the self-employed for the first time.’
But he added that ministers should do more to help working families now.
‘However, many parents will be very disappointed that the proposals will offer them no immediate help. The Government could still introduce some simple measures now – such as increasing the tax-free limit for childcare vouchers from the start of the new tax-year and introducing a right to request the scheme from their employer – which would help working parents straight away.’
Commenting on the Government's plans, United for All Ages said that the scheme would benefit wealthier families and leave some families worse off.
The social enterprise said that the new tax-free scheme would only offer the full benefits to those on higher incomes, able to spend £6,000 a year on childcare and would do nothing to stop the rising cost of childcare for families on low to middle incomes.
The funding would be recycled from the current tax exemption on childcare vouchers, which currently provides £933 per working parent, that is up to £1,866 for a family with two earners.
Stephen Burke, director of United for All Ages and the Good Care Guide, said, 'This will only benefit a limited number of parents and some will be left worse off. Many more families are facing the childcare crisis of rising costs and falling places. There is a real danger that the proposed tax break will push up costs further and create a two-tier childcare system.
'This is short-sighted. Access to childcare helps give children a good start in life and enables parents to stay in work. Research shows that parents who can return to work after having children have much better career and income prospects for the rest of their life. Better childcare is crucial to Britain’s future economic and social success.
'The Government needs a new national childcare strategy to make quality childcare more affordable and sustainable. This must include proper funding for free childcare places for two, three and four year olds. And the Government must simplify the complex funding of childcare to make better use of the funding and to target help to low and middle income parents. A new online childcare account would help achieve this.'