Giving town halls responsibility for paying council tax benefits to the poorest families while cutting funding by 10% has left them with a "difficult" challenge, it has been suggested.
Insisting English local authorities must also protect pensioners' claims means they face making cuts of up to 33% to working-age claimants, the Institute for Fiscal Studies said.
Almost six million of the poorest households receive the benefit, making it the most widely claimed form of means-tested welfare support.
The Government is abolishing the payment from 2013 and will give councils a grant to fund their own schemes.
The Scottish and Welsh administrations will also take control of payments at the same time.
Stuart Adam, a senior research economist at the IFS, said: "Councils face a difficult task to design replacement schemes that protect the vulnerable while maintaining work incentives in the context of reduced funding.
"They have little experience or expertise in designing means-tested support schemes and very little time to do it."
The IFS report, funded by the Joseph Rowntree Foundation, found the funding cut would hit the most deprived areas hardest.
If English councils follow the Scottish government by using funding from elsewhere to protect entitlements, it would require a 0.4% reduction in spending on local services or a 1.9% increase in council tax rates, it added.
Unless councils find additional money, the 10% funding reduction will jump to an average 19% for working-age claimants because of the guarantee on pensioner payments, the report found.
For local authorities with higher than average pensioner populations that could rise to more than 25% and, in areas like East Dorset and in Craven, North Yorkshire, 33%.
The IFS found reforms to meet the 10% funding gap would typically involve reducing support for those entitled to maximum council tax benefit, households on the lowest incomes, meaning they would have to pay some council tax.
James Browne, a senior research economist at the IFS, said: "Cutting support for council tax and localising it are two distinct policy choices: either could have been done without the other.
"Whether you think that cutting council tax support for low-income families is the best way to reduce government borrowing by £500 million will depend on your views about how much redistribution the state ought to do.
"But the advantages of localisation seem to be outweighed by the disadvantages, particularly as it has the potential to undermine many of the positive impacts of Universal Credit."
Local Government Association chairman Sir Merrick Cockell said: "Councils are extremely worried about how they're going to protect deserving and vulnerable people from the £500 million cut to council tax benefit next year.
"The cut goes way beyond the money that can be retrieved by cancelling discounts on second homes and empty properties and councils are being put in an impossible position. They can either cease helping the working poor, or continue to support them by taking money from other services or putting up council tax.
"It is telling that the Government's default scheme, which is what councils will have to apply if they do not cut benefits themselves, does not deliver the £500 million cut councils are being asked to implement.
"If the Government wants to localise council tax benefit, it needs to go all the way and give local authorities the freedom to make savings in a way which will protect the people who most need help."
- More about:
- Local Authorities
- Scottish Government
- Scottish Parliament