Childcare vouchers warning... again
A year ago we identified the possible downsides of taking childcare vouchers from your employer if you were on a low or modest income. We also criticised the lack of HMRC guidance. A year on, the traps are even worse and the HMRC guidance remains inadequate. We are concerned that this could be developing into a mis-selling scandal.
The Chancellor gave another boost for employers to give childcare vouchers to their employees in his 2006 Budget. He announced that from 6 April 2006 the maximum amount of these tax and NIC free vouchers were to be lifted to £55 per week or £243 per month.
This could save an employer up to £373 in employer’s National Insurance for every employee that takes vouchers.
All well and good, but in our experience neither those employers, nor the voucher companies or others who have a vested interest in selling vouchers, are able to advise people on low or modest incomes whether it is to their advantage to take them.
What both the employers and the voucher companies are likely to do is to suggest that the employees visit the HMRC website for advice (or they will quote reassuring words taken from the HMRC website).
What is the problem?
If you take vouchers and claim help with childcare through the tax credit scheme, you cannot count the vouchers as part of the cost of your childcare for tax credits.
This means that taking the vouchers – which saves you tax and National Insurance – also reduces the amount of money you can reclaim from HMRC through tax credits. If you don’t realise this, you will have a tax credit overpayment, which HMRC may seek to claim back from you. There may also be a penalty.
The rules say that you need to tell HMRC if your average weekly childcare costs fall by £10 a week or more for four consecutive weeks (or if you cease paying for childcare) as your tax credit award will need to be adjusted downwards to reflect the change. You must tell them within three months (soon to be reduced to four weeks) and failure to do so can incur a penalty.
This rule applies to you if you claim tax-free vouchers worth £10 a week or more from your employer, and as a result the childcare costs you can claim against your tax credits are reduced by £10 a week or more.
The interaction of the two schemes is not easy to understand, so we have provided some examples below for the tax credit year 2006/07 (which started on 6 April 2006) in the hope that it will warn people of the dangers. The position is different depending on a number of factors, including whether the individual is given a choice of vouchers or a pay rise, or is invited to sacrifice some salary for the vouchers.
We also hope that these examples will inspire HMRC to produce prominent warnings on their own website and many more examples for their customers.
Note however that these examples do not take into account the effect of any housing benefit or council tax benefit. People who are claiming either of those benefits, in addition to tax credits, and are offered cash or vouchers should always take advice on the effect it will have on their entitlements. Perhaps HMRC and the DWP can get together to produce some guidance for these customers?
Sharon's tale – vouchers or a pay increase
Sharon is a single mother with two children in childcare which costs her £300 per week or £15,600 per year. She is on £25,000 a year. She has done well and her employer wanted to give her a good pay rise from April 2006. The employer offered her £2,800 per annum in cash or £2,800 in childcare vouchers.
If she takes the pay rise there is no change to her tax credits entitlement this year and she pays 22p in the £ tax and 11p in the £ national insurance. This leaves her better off by £1,876, being her pay rise of £2,800 less 22% tax of £616 and 11% NI of £308.
If Sharon took the vouchers the childcare costs she can claim for tax credits are reduced by £2,800. She will thus lose 80p in the £ childcare credit worth £2,240. This means she is better off by £560.
Taking the vouchers would thus make Sharon worse off overall by £1,316 (£1,876 - £560) this year.
Next year her additional income of £2,800 will reduce her tax credits entitlement by 37p in the £. So if she takes the pay rise she will only be better off by £840 (£1876 less £2,800 @ 37%). Her net loss by taking the vouchers becomes £280 (£840 less £560) per annum from then on, assuming rates remain the same.
In addition, Sharon may lose extra State and company benefits (for example, pension, sickness or maternity benefits) through taking vouchers and having a lower salary.
Divya’s tale – sacrifice salary for vouchers
Divya has the same childcare costs and salary as Sharon, but her company cannot afford to give pay rises this year. However, her employer has heard about the voucher scheme and suggests employees might sacrifice £2,800 of their existing salary in exchange for £2,800 of vouchers.
If Divya took this advice, she would still be worse off by £280. She would lose the 80p in the £ childcare credit, while gaining only 70p in the £ (37p in extra tax credits, 22p in income tax and 11p in national insurance).
Like Sharon, Divya may lose extra State and company benefits (for example, pension, sickness or maternity benefits) through taking vouchers and having a lower salary.
Lucy is a single mother with one child who has childcare costs of £150 per week. Last year her employer recommended that she sacrifice salary of £1,000 so as to receive an equivalent amount of childcare vouchers. She pays tax at 22%.
As Lucy now loses out on the higher government subsidy of 80p in the £ from 6 April 2006 she will have to review her position. It is likely that she will be better off by £100 by giving up her vouchers in exchange for cash, if the employer is willing to reverse last year's salary sacrifice.
The £100 is the difference between £1000 at 80% and £1000 at 70%. Last year she was no worse off by accepting the salary sacrifice (except loss of other benefits like pensions).
Abigail and Alfred’s tale
Abigail and Alfred have three children and joint income of £55,000. They both work at least 16 hours per week and incur childcare costs of £300 per week. Alfred is a higher rate taxpayer and is offered £2,800 of vouchers under a salary sacrifice scheme. If he takes the vouchers he may save tax and NI of £1148 but he decreases his tax credits claim by £1204, leaving him worse off by £56. (If the salary sacrifice takes Alfred out of the higher rate bracket he will be worse off by more than £56 as his tax saving will be less.)
Wanda’s tale – higher rate taxpayer who does benefit
Wanda is a single mother with one child who lives in Central London. She pays childcare costs of £275 per week. She earns £60,000 and is a top rate taxpayer. Her employer offers her a salary sacrifice of £2,860 in exchange for the maximum tax advantaged vouchers (£55 x 52). She will be likely to save £1,242, because:
- her childcare costs have reduced by £2,860;
- her net salary has reduced by £1,687 (salary sacrifice of £2,860 less tax and NICs of £1,173); and
- her tax credits have gone up from nil to £69.
On the whole, as the examples show, people on higher incomes, with childcare costs above the maximum eligible for relief through tax credits (£300 a week for two or more children, £175 for one), are likely to benefit from getting childcare vouchers from their employers. But people on more modest incomes, whose childcare costs are no more than the maximum figures quoted above, will more often lose out.
It is likely that thousands of employees do not appreciate that they could be better off without the vouchers, and the lack of detailed information provided by both HMRC and the voucher companies (and some employers) contrives to keep those who need to know in the dark.
It is also very likely that many thousands of tax credit claimants have failed to appreciate that they should have notified HMRC that their childcare costs have been reduced by their accepting vouchers.
Below are some quotes from voucher companies and major employer websites which illustrate as we start the new tax year how much more communication is necessary.
- Parents can save tax and National Insurance contributions on their childcare costs (up to £50 per week, £2600 per year). For most parents, this equates to an annual saving of between £816 and £1,066 depending on personal circumstances.
- Many working parents benefit from both Tax Credits and Childcare Vouchers. It is however always advisable for you to check with the Tax Credits Helpline that it will be in your interests to claim Childcare Vouchers as well as Tax Credits, as everyone's case is slightly different. [major voucher company]
- This means that in families where both parents are taxpayers there are potential savings of between £1,924 and £2,392 per annum. This will significantly benefit most families in the UK and vouchers will quickly become the recognised method to pay for all forms of registered childcare.[major voucher company]
- We offer an entitlement which enables our employees to order childcare vouchers in place of some of their pay. We deduct the monetary value from their pay and they save £’s as they don’t pay National Insurance on the amount paid out for vouchers. In some cases they could save as much as one month’s childcare over a period of 12 months. [borough council]
- Big savings for business and staff - Childcare Vouchers and Childcare Vouchers are Tax and National Insurance exempt for £50 per week. You could save around £300 per year for each employee choosing Childcare Vouchers whilst employees will save between £816 and £1,066 per year.[major voucher company]
- The amount you save depends on the level of tax and NI you pay - With NI at a rate of 9.4% and £50 of your salary per week taken as vouchers you will save up to £816 p.a. as a 22% tax payer, and up to £1066 p.a. as a 40% tax payer.
- There may be an effect on the childcare tax credit element of the WTC. It is advisable to contact the WTC helpline on 0845 300 3900 prior to applying for childcare vouchers.[major employer]
What is wrong with the HMRC website?
The HMRC website needs a prominent Health Warning, which it currently does not have.
You can be guided on the website to do some or all of the following if you need advice:
- visit an Enquiry Centre
- telephone the Tax Credits Helpline
- telephone the Employers Helpline
We suggest that you do none of those things as, in our experience, detailed advice on this subject is beyond the scope of help offered.
The best advice (which was produced following pressure from us on this subject last year) is tucked away and the casual browser is likely to have to wade through some 200 pages of other bumf before stumbling across it. It is, also, not right up to date for people trying to take decisions now.
Since 2005 a number of improvements to the tax credits regime have made it even more likely that it will be to an employee’s disadvantage to take childcare vouchers if the employee is on a low or modest income.
These decisions are complex and HMRC need to go the extra mile to help the majority who will not have any alternative source of advice.
We are also looking for HMRC to remove the words quoted by us last year as misleading but still retained by them in their literature and quoted by voucher companies as a sales endorsement:
Families will always benefit from taking a tax and NICs-free voucher if it is offered to them on top of their salary
In our experience it is very unusual for an employer to offer a workforce childcare vouchers with no alternative. But employees reading these words may assume that they have a “government guarantee” that they will be better off.
If HMRC attempt to seek penalties from individuals who have over-claimed because of receiving vouchers, or if HMRC try to collect the resultant overpayments, there is a case for arguing that there has been “official error” because of the lack of information given to claimants.
There is an incredible amount of misleading information out there. We would really like to see the system simplified but if this is not possible, HMRC and voucher providers do need to provide comprehensive and understandable guidance on their websites and in their leaflets and promotional material.
There may already be a mis-selling problem. Action needs to be taken now to prevent it becoming a mis-selling scandal.
Contact Name: John Andrews (Tel: 020 7235 9381, Fax: 020 7235 2562)