News

The benefits and tax credit system can come up with some strange results, but I've rarely come across anything as bizarre as the recent introduction of "extra" help with child care costs which could make some families worse off if they claim it.

The TUC and the Low Incomes Tax Reform Group (LITRG) have even sent out a warning that some families can lose more in tax credits than they gain in tax and national insurance exemption by accepting the newly introduced child care vouchers provided by employers.

Under the scheme, introduced last month, parents can choose to "sacrifice" up to £50 a week of their salary in exchange for child care vouchers, exempting them from tax and national insurance on that part of their pay. In other words, some of their child care will be paid for out of pre-tax as opposed to after-tax income.

The scheme looks simple, appears advantageous to parents and fits in neatly with the government's child care strategy. There's just one problem: it could leave some parents out of pocket.

Consider, for example, someone who has child care costs that come under the child care element of working tax credit but who chooses to receive vouchers through a salary sacrifice scheme. The amount of their child care costs that are then eligible for the child care element of working tax credit will be reduced by the amount covered by the voucher. This could more than offset the gains they make on not paying tax and national insurance on the sacrificed salary.

The LITRG has warned that the official Inland Revenue publicity about the scheme (leaflets IR115 for employees and E18 (2005) for employers) doesn't give enough information about how individuals can lose out by taking vouchers.

Also, the employee leaflet makes no reference to the potential loss of employer or state benefits incurred by giving up salary for vouchers. This would happen where benefits are based on salary because sacrificed salary does not count as income.

It will be the lower-paid and middle income employees who will have to be most careful if they are not to be disadvantaged through the loss of working tax credit. Sellers and providers of vouchers often don't understand the implications for tax credit claimants, or play down the risks if they do.

The LITRG has produced a number of examples that show how this might work in practice. Here's one:
Tina is a single mum working 20 hours a week in a care home for £6,240 a year. Her employer gives her the choice of either a pay rise of £20 a week or a child care voucher of £20 a week. Tina currently pays £100 a week in child care costs at an approved nursery.

If she takes the £20 a week cash, her income after tax goes up by £786 a year. This level of increase won't affect her current working tax credit award. But if she takes the £20 weekly voucher and uses it to pay the nursery, she saves £1,040 over a year, but then loses £728 of the child care element of her working tax credit, making her only £312 a year better off.

Given the complexity of this issue, and the difficult "better-off" calculation involved for some workers, surely the Inland Revenue needs to take the lead and issue proper advice individually?

Gary Vaux is head of money advice, Hertfordshire Council. He is unable to answer queries by post or telephone. If you have a question to be answered please write to him c/o Community Care.