Urgent health warning for Childcare Vouchers
Employer provided childcare vouchers which are free of tax and national insurance up to £50 per week are to be introduced from 6 April. Employers are being encouraged to provide them for their staff, but many people will be worse off if they take vouchers rather than a cash alternative.
It will be the lower paid and middle income employees that will have to be most careful if they are not to be disadvantaged. LITRG wants everyone taking advantage of this government sponsored initiative to be sure they understand their own position. The Inland Revenue have done little so far to explain the complexities for 'the man in the street'.
The Inland Revenue have issued guidance in two leaflets IR115 (for employees) and E18 (2005) (for employers). Unfortunately the advice primarily concentrates on the tax/NI savings and there are no worked examples showing how individuals can be much worse off by taking vouchers.
Sellers and providers of vouchers similarly play down any risks to the tax credit claimant.
LITRG are concerned that a significant minority of people may, through ignorance, have a nasty surprise awaiting them.
In this article we show how families on higher rates of tax credit can lose more in tax credit than they gain in tax and NIC exemption by accepting vouchers. To see how this works in individual cases, scroll down to the examples of Tina, Sharon and Dawn.
Background to problem
Families that are at the lower end of the income scale are entitled to Working Tax Credit and help with up to 70% of their childcare costs, subject to certain ceilings. Having your employer pay the childcare with a voucher can mean you lose some of your WTC at a rate of 70p in the £.
The only reference to this issue in the Revenue leaflet for individuals is this statement:
Childcare or childcare vouchers could affect the amount of tax credits that you are entitled to, particularly if you give up some of your salary to join your employer's childcare scheme. You could end up with less money overall.
As we will show later, the loss can be particularly damaging if you choose to take vouchers as an alternative to, or part of, a pay rise. This is not covered at all in the Revenue leaflet.
No reference is made in the leaflet to the losses the employee can potentially suffer in employer's or state benefits through giving up salary for vouchers.
If the individual wants more help on how to choose between the two, they are directed to the Tax Credits Helpline or the Revenue website. Neither are, at this time, particularly helpful.
On the Revenue website there is a Question and Answer which gets repeated in the literature of others.
Will I be better off accepting childcare vouchers in return for a salary sacrifice or claiming tax credits help towards my childcare costs?
- Families will always benefit from taking a tax and NICs-free voucher if it is offered to them on top of their salary.
Unfortunately this answer can be misleading as it is only true if your employer is offering you a voucher on top of your salary with no alternative (such as cash). Although the Revenue proceed to give caveats to this answer, they are expressed in language that will not be understood by the vast majority of working tax credit recipients.
Complexity heaped upon confusion
To come to the right decision, some or all of the factors below will have to be taken into account:
- Whether the vouchers are to be used to replace childcare costs which are not attracting tax credits relief at 70%
- Whether increases in salary are under or over the £2,500 disregard, if the vouchers are used in a flexible benefits scheme where employees can choose cash or benefits (and for those with partners we need to look at the joint position)
- The rates of tax payable by the individual
- The rates of national insurance payable by the individual
- Whether the individual's income (and for those with partners we need to look at their joint position) is high enough to have fully tapered away tax credits at the 37% rate
- The impact of the national minimum wage
- The potential loss of employer's and state benefits arising from choosing vouchers rather than cash
- The introduction of vouchers part way through the tax year, or changes in circumstances during the tax year (for example, the loss of or acquisition of a partner, or loss of employment by a partner) will affect the sums
- If the vouchers are to run into 2006/07 the equations will change again when the childcare tax credit loss will rise to 80p in the £.
In general, the people who stand to benefit most from these provisions are the very highest earners as they are not entitled to fast taper credits; their tax and NIC savings are the greatest; and they are likely to be paying for more expensive childcare.
The immediate need
LITRG would have liked the government to have introduced a system with less complexity and with no downsides for those on low and middle incomes. But we are where we are, so as a very minimum LITRG want no individual to take vouchers without understanding the consequences of their actions. We also want employers to realise the damage that could be caused if the generous gesture does not look so generous when the employees feel the impact on their tax credits or related benefits.
It is essential that:
- The Revenue's Tax Credits Helpline is geared up from 6 April to provide the Tinas, Sharons and Dawns of this world (see the examples which follow) with help to make the right choices
- Every Revenue Enquiry Centre or JobcentrePlus office can handle the detailed evaluation for individuals who call in to obtain advice
- The Revenue's literature and website is made more helpful and much less of a selling document for vouchers
- Those organisations who promote or sell vouchers must explain the financial risks attached for recipients
- Employees who take vouchers must be advised what notifications by them to the Revenue are necessary.
The following examples will illustrate the need for our recommendations:
Tina is a single mum working 20 hours a week at her local supermarket and getting £6,240 per annum. Her employer has introduced a new voucher scheme as from 6 April 2005 and gives her the choice of either a pay rise of £20 per week or a childcare voucher of £20 per week.
Tina has one child Lucy aged 3. She currently pays £100 per week in childcare costs at an approved nursery.
Tina will need to do two calculations.
If she takes the £20 per week cash her income rises by £1,040 for the year but she will pay extra tax and national insurance of £254, but her WTC remains the same, so she is £786 a year better off (£1,040 less £254).
If she takes the 'tax/NI free' voucher of £20 per week she saves paying the child carer £1040 for the year but she loses £728 of the childcare element of her WTC, so she is only £312 a year better off (£1,040 less £728).
Therefore Tina is better off by £474 (£786 less £312) by having a simple pay rise rather than a voucher. This benefit will fall in 2006/07 when her rise in income will reduce her tax credits by £1,040@37% (the increase in income of £2,500 only being ignored in the first year), but her tax credits on childcare of £20 per week will increase by £104 as the rate of childcare credit rises from 70% to 80%.
If the employer had not offered Tina a pay rise but instead offered her the possibility of sacrificing some of her existing salary in exchange for receiving a voucher, Tina would still be better off refusing the offer. This is because accepting the voucher reduces her tax credits by £351 but only saves her tax and NI of £218. She is better off by £133 in keeping her salary and provided her rate of tax and NI do not change in 2006/07 she will continue to be better off not accepting a voucher.
Tina also has to take into account that when considering the alternative of a voucher that cash salary can provides a basis for further employer benefits, for example, employers can give pension scheme contributions based on an employee's salary or death, accident or permanent sickness benefits. These are unlikely to take account of a voucher.
Similarly reducing or keeping down her cash income could harm Tina if she might want to claim State benefits such as Statutory Maternity Pay or Statutory Sick Pay. There could also be losses in State pensions, Jobseekers Allowance, Incapacity Benefit and Maternity Allowance. These may not be relevant, but they are certainly more relevant to people on the lowest incomes.
Sharon is a single mother with two children in childcare which costs her £250 per week. She is on £25,000 a year. She has done well and her employer wants to give her a good pay rise from April 2005. The employer offers her £50 per week in cash or £50 per week in childcare vouchers.
If Sharon takes the vouchers she will be £925 worse off than taking the cash. She may also lose out on the other employer and State benefits mentioned for Tina.
If Sharon was offered a salary sacrifice arrangement whilst on her current income it is likely she would neither have gained nor lost anything. But next year, when the rate of childcare tax credit goes up to 80%, she would be better not accepting the voucher. Her tax credits will be higher than her tax and NI savings (assuming tax and NI rates remain the same).
Dawn's clear choice
Dawn has one son aged 4 and pays £150 per week for his childcare. She is registered blind and is taking her first steps to get into the employment market. She works 16 hours a week and is paid the national minimum wage. Her total income is £4,035.
A sympathetic alternative employer has approached her and offered her a new job from the start of April which will give her an increase in income of £2,500 a year and she can have the increase in either cash or vouchers.
Dawn would be over £1,500 worse off in the first year and perhaps £1,000 worse off in 2006/07 through taking vouchers due to her much lower tax and national insurance liability.
A salary sacrifice would not have been possible for Dawn on her existing income as her cash wage would take her below national minimum wage levels.
Contact Name: John Andrews (Tel: 0844 579 6700, Fax: 0844 579 6701)
Relevant Link: Revenue website guidance