Tax relief on childcare vouchers to go - a blessing or a curse?

Published on 13 November 2009

Childcare vouchers have become front page news this week following the Government’s announcement that they plan to abolish tax relief on them. Tax relief on childcare vouchers may help high earners, but families on low to middle incomes are generally better off claiming tax credits. Yet there is precious little information to help people make the right choice.

Over 75,000 people have signed a petition urging Gordon Brown to reverse the decision to abolish the tax advantages of childcare vouchers and 88 MPs have signed an Early Day Motion calling for the Government to consider the implications of the proposed changes.

Around 340,000 families have signed up for vouchers. Some of those families would lose out financially if these proposals go ahead. For others, possibly including some who have signed the petition, the move could be a blessing in disguise.

Since 2005 we have written no fewer than 7 articles warning parents about the complexities of childcare vouchers and why, despite the fact that the savings may look impressive, many parents are better off not taking them. Our most recent articles were highly critical of the information given to parents by both the Government and voucher companies to enable them to make the right decision.

Despite this we have continued to come across families who, through no fault of their own, now have large tax credit overpayments or who have lost out financially by claiming childcare vouchers when tax credits would have been more appropriate.

The benefits of childcare vouchers

Employers can offer favoured childcare vouchers of up to £55 a week to employees. These vouchers can then be used to pay for certain types of childcare. Generally this is done by exchanging part of an employee’s cash salary for the vouchers (called a ‘salary sacrifice’), although some employers may offer vouchers on top of an existing salary.

The benefits of the scheme for employees are that the vouchers can be taken free of income tax and Class 1 National Insurance Contributions, whilst the employer benefits from a NIC saving as well. This can mean significant savings, principally for higher rate taxpayers.

It is these benefits that are highlighted by employers, voucher companies and even Government websites.

But no-one claiming tax credits should sacrifice salary for vouchers without having a personal calculation done to prove that they will be better off.

The dark side of childcare vouchers

As with most things in family life, the decision to take vouchers is not straightforward. Although on paper the vouchers look appealing, in reality the complicated interactions with tax credits mean that very many families are better off getting support for childcare costs through the tax credit system and not sacrificing salary for vouchers.

The first important point for parents to note is that they cannot claim childcare support through tax credits on childcare costs covered by the vouchers. For example, if you have childcare costs of £155 a week and get vouchers of £55, you can only claim your eligible childcare costs as £100 for tax credit purposes.

The second important point to note is that you must tell HMRC if you start to get childcare vouchers because it will mean your eligible childcare costs are likely to have changed by £10 a week or more. Failure to do so can mean large overpayments are created (which HMRC will try to recover) and a possible penalty of £300 for failure to report a change of circumstances.

These two crucial points are often overlooked or buried deep in information given to parents about childcare vouchers.

Better off with tax credits?

As mentioned above, you cannot claim tax credits on childcare costs that are paid for by the vouchers. Although taking the vouchers gives some national insurance and tax gains, you lose the 80% subsidy that comes with tax credits. Therefore parents must do a complicated calculation to see which is better for them.

A further complication is that voucher savings are based on current year income, whereas most tax credits awards are based on income from a previous year. This makes it incredibly difficult to develop any accurate guide that suits all families.

Although not a comprehensive list, the following categories of people are most likely to benefit from taking childcare vouchers:

  • People who pay a significant amount of tax at 40% on their income, both before and after accepting vouchers.
  • People whose childcare costs exceed £175 per week for one child or £300 for two or more children.
  • Couples whose joint income is too high to benefit from the childcare element of working tax credit.
  • People who are not entitled to claim working tax credit, for example, because their hours worked are too low or because they are subject to immigration control.
  • People whose employer is only prepared to give an increase in pay by means of childcare vouchers with no cash alternative.

However, these are not absolute rules and are still subject to some exceptions. For everyone else, the only way to know what to do is to perform a difficult calculation.

The consequences of getting it wrong

In our previous article we highlighted the misleading advice given by HMRC and other Government departments to parents. Most of the sites do little to warn parents of the dangers of taking vouchers. Many choose to send parents to the HMRC Childcare Indicator, which professes to show people whether they will be better off taking vouchers or tax credits. However, as we have pointed out on many occasions, the HMRC indicator is itself flawed because it doesn’t ask for previous year income which is essential to give an accurate tax credit figure.

As a result we have seen cases where parents have taken vouchers and claimed tax credits on the same childcare costs, only to find that they now owe large amounts of money to HMRC in tax credit overpayments. We have also seen examples of families who have taken childcare vouchers because they thought it would save money, when in fact they would have saved more money by claiming childcare costs through tax credits.

We wonder how many more of the 340,000 families now claiming childcare vouchers will find themselves in the same position in the future.

Should tax relief on childcare vouchers be abolished?

The decision to abolish tax relief on childcare vouchers is one that will be taken by the Government. If the proposal does go ahead, it may not affect current claimants for a few years.

Undoubtedly there are many families who benefit from the tax relief and who will lose out financially if it is abolished. However, our concern is that some of the families currently claiming the vouchers may actually be worse off by doing so, and if they are claiming tax credits on the same childcare costs, they could unknowingly be building up substantial tax credit overpayments.

Whether or not the Government decide to abolish the tax relief, we call on them to ensure that all parents are provided with adequate information to make the correct decision and that any related tax credit overpayments are written off in light of the poor information that has been available to date.

Some enlightened voucher companies will do a detailed better-off calculation for their clients and we welcome that approach.

We urge all parents who are currently using childcare vouchers to make sure that they have made the right choice and only then will they know whether the vouchers are a blessing or a curse.

(13-11-2009)

Contact: Victoria Todd (0844 579 6700 Fax 0844 579 6701)