Parents across the UK will be able to claim back up to £1,200 a year - or 20% of childcare costs - from 2015, under plans unveiled by the government.
Parents will be allowed to claim back 20% out of a total of around £6,000 - what they believe to be the average annual price of a childcare place.
The PM said the plans, expected to cost £1.4bn, would be a "boost direct to the pockets of hard-working families".
But Labour said parents would be disappointed not to get help sooner.
Britain has some of the highest childcare costs in the world, with many people with two or more children saying it does not make financial sense for both parents to work.
The government says it expects the new tax-free childcare scheme to help 2.5 million working families.
That is significantly more than the current employer-supported childcare voucher scheme, which is provided by only around five per cent of employers.
But it is not yet clear whether parents will be better off under the new scheme or the existing voucher schemes.
To be eligible for the new support both parents will have to work, with each earning less than £150,000 a year.
Where one parent does not work, families will not receive support - which is said to be underline the government's support for making work pay.
Half of the funding for the new scheme will come from the abolition of the previous system of childcare vouchers, and in part by funding switched from elsewhere in Whitehall.
Sources across Whitehall told BBC Newsnight's political editor Allegra Stratton they were "jubilant" a deal had been struck, with one saying the four-month negotiations had been a "monumental battle".
But Prime Minister David Cameron said too many families were finding paying for childcare "tough" and were "often stopped from working the hours they'd like".
"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," he added.
Deputy Prime Minister, Nick Clegg said he wanted to help "every family to get on in life".
He said: "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."
Under the current employer supported childcare voucher scheme, parents can receive vouchers for childcare worth up to £55 a week. This sum is deducted from their salary before tax is paid.
The Treasury says parents will be able to open an
online voucher account with a voucher provider and
have their payments topped up by government.
For every 80p families pay in, the government will
put in 20p up to the annual limit on costs for each
Parents will be able to use the vouchers for any
Ofsted regulated childcare in England and the
equivalent bodies in Scotland, Wales and
The scheme is expected to benefit 2.5 million
Full details of the new scheme will be set out in a
The saving in tax and national insurance is typically worth about £900 a year for a basic-rate taxpayer. Where both parents work, families can save about £1,800 a year.
These vouchers are available only to employees whose employer is part of the scheme, but the new policy is expected to be open to all working parents who meet the criteria.
Parents who already claim childcare vouchers through the old scheme will be able to continue to do so if they wish, but it will be closed to new claimants who will be moved to the new tax-free childcare scheme.
The new system will be phased in from autumn 2015, with children under five helped in the first year. The scheme will then build up over time to include all children under the age of 12.
The government has already announced changes to allow nurseries and childminders in England to look after more children, which it says will make more childcare places available and reduce costs for parents in the "long term".
Labour's shadow education secretary Stephen Twigg said: "Parents will be disappointed that three years into this government they will not get any help with childcare costs for another two and a half years.
"While working parents won't get any help before the next election, David Cameron is happy to help millionaires with a tax cut now."
He said the measure would not make up for the cuts the government has already made to support for children