LITRG warn of the potential hazards when sacrificing salary for childcare vouchers where you are also claiming tax credits, and stress the importance of doing the sums.
Tax relief on childcare vouchers
At the end of 2009, campaigns were launched to save the tax advantages of childcare voucher schemes. Comments which described the proposed withdrawal of tax relief on them as an attack on “hard working families” were misguided as many families are in fact better off declining any employer offers to sacrifice salary for vouchers.
With the tax advantages of vouchers for higher-paid people being removed from 2011 there will be a big push to sell vouchers in the current tax year so as to obtain transitional protection. But we urge you to understand the rules before you give up salary.
For those people who wish to understand the basic principles of childcare vouchers we suggest that you have a quick glance at one of our earlier articles on the LITRG website.
The most important thing to realise with childcare vouchers is that taking them in exchange for salary sacrifice needs individual analysis person by person. There are, however, some broad principles which can help you on your way.
Broad principles
The broad principles are:
- You cannot take vouchers from your employer and claim tax credits on the childcare costs covered by those vouchers. If you do, the tax credits will be overpaid and you will have to pay them back.
- When you sacrifice salary for vouchers you may lose:
- Entitlements to a range of State benefits
- Benefits from your employer which could be based on your salary level
- Your net salary on the amount sacrificed
- Tax credits of up to 80% of the childcare costs you currently pay - By sacrificing salary for vouchers you may gain:
- A reduction in your tax liability
- A reduction in your national insurance payments
- An increase in your tax credits entitlement because your income has gone down by the amount of salary you have sacrificed
- Your employer’s subsidy of your childcare costs
As if the complexity of balancing tax credits, tax and national insurance were not enough, if you are in receipt of benefits such as Housing Benefit and Council Tax Benefit you need to take potential changes to those benefits into account as well.
Another way of comparing the respective benefits of tax-free vouchers and salary sacrifice with tax credits for childcare costs is to look at the amounts saved in each case. However, the complexity of the two systems becomes evident when you attempt to do so. Whether you gain or lose a particular amount depends on your exact circumstances. Another broad brush way of looking at the same thing is to consider the percentages involved of the amount sacrificed:
Vouchers and salary sacrifice:
| Tax saved | 20% |
| NIC saved | 11% |
| Tax credits gained because of salary sacrifice | 39% |
| Total gain | 70% |
As against claiming tax credits on childcare costs:
| Tax credits subsidy lost | 80% |
It follows that for basic rate taxpayers:
- who are in receipt of tax credits at a rate higher than the child tax credit family element of £545 a year (£1090 if there is a baby under 1) and who receive a full 80% of their childcare costs (either through the childcare element of working tax credit or via increased child tax credit), and
- whose childcare costs are equal to or lower than the amount for which tax credits can be claimed (£175 a week for one child, £300 a week for more than one),
it is generally beneficial to claim tax credits on childcare costs and not sacrifice salary in order to take employer-provided tax-free childcare vouchers.
However, there is no such certainty for basic rate taxpayers who receive less than 80% of their childcare costs (either through the childcare element of working tax credit or via increased child tax credit). They may find they are, in some cases, better off taking vouchers and those who have tax credits based on previous year income may find they do not gain 39% via tax credits initially.
These added complexities mean that the only way to decide whether taking vouchers is the right decision is to carry out a calculation like the one above based on your own individual circumstances, including the impact on any means tested benefits. It is also important to re-calculate any potential losses or gains at the start of each tax year and when any major change of circumstances occurs.
Some simple examples
In the table below we have set out eight typical cases where people would be worse off sacrificing salary for childcare vouchers. We could have taken other cases where individuals were better off with vouchers, but we are only interested in showing the consequences for individuals for whom a sacrifice of salary is likely to be a bad idea.
| Background facts | Amount per week sacrificed | Annual loss due to sacrifice |
| Lisa is a lone parent with one child who works 37 hours per week. Her income in 2009/10 was £15,000 and in 2010/11 will be £16,000. She pays £110 per week childcare costs. | £55 | £681 |
| Ken and Winnie have two children. Ken works full time and has an income of £12,000 per annum. Winnie works 16 hours per week with an income of £5,000. They pay £90 per week childcare costs. | £45 by Ken | £238 |
| Jackie is a lone parent who works 32 hours per week. Her income is £14,000. Her childcare costs are £105 per week. | £30 | £159 |
| Wayne and Angela have one child. Wayne works 37 hours per week with an income of £16,400. Angela also works 37 hours per week with an income of £14,200. They pay £150 per week childcare costs. | £55 by Wayne | £291 |
| David and Joy have two children. She works 30 hours earning £30,000 and he works 20 hours for £9,000. Their childcare costs are £110 per week. | £55 by Joy | £178 |
| Pam is a disabled parent who qualifies for the severe disability premium of Working Tax Credit. She has two children and pays £125 per week childcare costs. Pam works full time, has a company pension, and in 2008/09 her income was £15,000 increasing to £25,000 in 2009/10 and remaining at £25,000 in 2010/11. | £50 | £1,341 if Pam sacrificed salary for vouchers in 2009/10, but £307 if she waited until 2010/11 to do so. |
| Shao-Ling is a lone parent with a disabled child. Her childcare costs are £125 per week. In 2008/09 her income was £14,000 but after moving to a new job her income increased to £35,000 in 2009/10. She expects it to stay the same in 2010/11. | £55 | £1,428 if Shao-Ling sacrificed salary for vouchers in 2009/10, but £59 if she waited until 2010/11 to do so. |
| Charlotte is a lone parent with three children, one of which is disabled. Her childcare costs are £110 per week. She works 42 hours per week and is a higher rate tax payer. In 2009/10 her income was £50,000 and she expects it to be £55,000 for 2010/11. | £55 | £616 |
Advice given to employees is often misleading
If you ask your employer to explain to you how you will benefit from taking childcare vouchers, they will probably refer you to the voucher company, who will in turn tell you to consult HMRC.
HMRC will tell you that they cannot provide advice in individual circumstances, but they may refer you to their “better off calculator”. There is a very unclear explanation of what the calculator can do on their website and the calculator itself is unfriendly and sometimes confusing.
Throughout its life the calculator has never been free from error. Although things have improved recently, it is still quite possible that you will be misled.
For example, if you took the final example above regarding Charlotte and ran it through the HMRC calculator it will tell you that Charlotte would be £6 better off through taking vouchers. As we have shown Charlotte would be £616 worse off, despite being a higher rate taxpayer. We are pressing HMRC for some more re-programming.
The solution
As the examples above show, many “hard-working families” can lose out by choosing to take childcare vouchers. The attractive tax and national insurance savings advertised soon dwindle away once the full impact on tax credits is taken into account. More worrying is that some unsuspecting families may be claiming both vouchers and tax credits, thus building up a tax credit overpayment which HMRC are likely to want back in the future.
The solution firmly lies with HMRC and their better off calculator which, if programmed correctly and made clearer, would provide a tool which would not only remove some of the complexity but more importantly will mean people have the information to make the right choice.
Please register or log in to add comments.
The tighter scrutiny of what paases as an effective scheme is to be expected, thus we have seen HMRC clarify the position on Bikes for work, and Green Transport. <br /> My question, given HMRC requirement that a scheme is offered to ALL employees, is how one meets that test yet continues to offer "Wine club" through a Flexible Benefits scheme where an employee is below the age alcohol can be legally purchased, or where fixed term contractors' leave date may preceed the end of the minimum lease period of Bikes for work?