With increasing numbers of people losing their jobs, the implications of taking childcare vouchers rather than salary should be reconsidered, even amongst those people for whom it makes sense in normal circumstances.
The effect of salary sacrifice
Most childcare voucher arrangements ask you to sacrifice your salary in exchange for vouchers. So your salary is legally reduced.
A salary reduction may reduce the value of other benefits provided by an employer dependent upon the rules of the schemes. Any scheme which involves the benefit being based on the actual (rather than notional) salary level of the employee may be affected. For example, the following benefits might be based upon levels of salary:
- Pension benefits
- Death in service benefits
- Accidental death benefits
- Sickness benefits
- Share schemes
- Company redundancy or severance arrangements
- Bonus plans
- Relocation schemes
A good employer should advise an employee of the knock-on effects of salary sacrifice on company benefits when childcare vouchers are proposed. Any employee not receiving this information should ask for it.
Many State benefits are based upon the level of salary and the amounts of national insurance paid by the employee. Some which could be affected by a salary reduction might include:
- Retirement pension
- Contribution-based Jobseekers Allowance
- Contribution-based Employment and Support Allowance
- Statutory redundancy pay
- Statutory maternity, paternity and adoption pay
- Statutory sick pay
Employees should consider whether they might be disadvantaged in these circumstances.
The recession and vouchers
Some people who exchange salary for childcare vouchers lose some or all of their childcare tax credits and this could make them worse off. These people are mainly basic rate taxpayers who receive more in tax credits than the basic amount of £545 a year.
But, as we showed in our last article, there are others who should always gain initially when sacrificing salary. This advantage however can be reversed and lost altogether should an individual lose their job or have their working hours reduced.
This is because in working out whether you are better off or worse off taking childcare vouchers you have to look at your income for the whole of a tax year. In broad terms, the higher your income for the year, the more chance of childcare vouchers being to your advantage.
But if you lose your job the childcare voucher advantage can disappear:
Julie is a single mother earning at a rate of £50,000 a year in April 2009 and she sacrifices £55 a week in salary in exchange for £55 a week of childcare vouchers, which she uses to pay for part of her childcare costs for her two children. She had used HMRC’s calculator which showed that she would gain from the sacrifice of her salary for vouchers. In September 2009 she is made redundant and she remains unemployed for the rest of the tax year. It then becomes clear that her exchange of salary for vouchers has lost her money as she never becomes a higher rate taxpayer for 2009/10.
So when making your childcare voucher choice you have to consider your likely future financial position as well.
Help from HMRC?
Before last Christmas and after the recession had begun, HMRC announced that they had revised their leaflet IR115 Paying for Childcare. This leaflet is a key information source and widely distributed. But sadly there are many things that could be improved within it.
- It does not explain how to choose between tax credits and childcare vouchers, and taking vouchers may not be to someone’s advantage. This is unfortunate as childcare vouchers are being widely promoted as one way to save money in a recession.
- It recommends that you consult HMRC’s online calculator to see if you are better off taking vouchers. But the online calculator can give incorrect answers if you have fluctuating income year on year. We have told HMRC this, but they have done nothing to correct the position.
- It also recommends that you speak to the Tax Credits Helpline. But if you do, the Helpline will tell you they cannot give guidance on childcare voucher issues.
- Nowhere does it warn a parent that if their childcare costs go down by £10 a week or more and the change lasts for at least four weeks in a row, they must notify HMRC within one month. A failure to do so will lead to an overpayment and potentially a penalty of up to £300. Using childcare vouchers to pay for childcare is one of the most common reasons for childcare costs to go down.
- Without mentioning the risks the leaflet suggests some strategies which could backfire:
- “If you do not wish to use the vouchers immediately you can save them up to use later. For example, your childcare costs may be more than usual during school holidays, and you may want to use them then.”
Many claimants do not realise that if you take up vouchers you can lose your 80% tax credits subsidy, because you cannot claim tax credits on costs which are borne by someone else.
Moving on from the IR115 leaflet, the more detailed childcare guidance on the HMRC website gives a fuller explanation of when claimants are obliged to notify HMRC that their childcare costs have fallen.
However, the text has not been updated for some time and it states incorrectly that the time limit for notifying HMRC of a drop in childcare costs is three months. As the time limit is in fact one month you could incur a penalty and an overpayment by following HMRC advice.
HMRC have announced that they are having a big push to attend Children’s Centres to hand out advice. We have a sinking feeling that leaflet IR115 will be a key piece of information for distribution.
Once more we beg HMRC to get their act together and even if they cannot get their calculator corrected due to cost constraints, then at least put appropriate warnings on it. They also need to update and correct their other material on childcare vouchers. HMRC know this misleading advice is quoted by many websites as the authoritative view, so this compounds the problem.
If a taxpayer continued getting their own tax affairs wrong after being warned , HMRC would say that at the very least it constituted failure to take reasonable care, and impose a penalty of up to 30% of the tax at stake.
Contact Name: John Andrews (Tel: 0844 579 6700 , Fax: 0844 579 6701)