Childcare help could be stealing candy from your babies

Parents can now claim help with childcare costs, but not all families will be winners says David Prosser

he Chancellor of the Exchequer Gordon Brown believes that concentrating Government spending on the most needy is the best way to close the gap between rich and poor. But his strategy may be coming unstuck: a fortnight ago, the Treasury was lambasted for allowing the tax credits system to descend into chaos. Now, its attempts to help parents with the cost of childcare could backfire just as embarrassingly.

In April, the Chancellor proudly launched a new scheme allowing employers to offer their staff childcare vouchers worth up to £50 a week in place of salary. The vouchers are tax-free, so parents can save up to £2,000 a year on the cost of childcare, depending on their income and tax status.

However, while the concept is attractive, experts warn that many parents may actually end up worse off under the scheme – not least because parents on low incomes will jeopardise their right to claim tax credits if they apply for the vouchers. And those who are earning more could jeopardise other areas of their personal finances by claiming help.

"If you look at childcare vouchers in isolation, the idea seems very logical, but once you consider the way this interacts with the tax credit system, it's very worrisome," says George Bull, a tax partner at accountant Baker Tilly. "The problem is that people who claim the vouchers will end up in difficulties with the Inland Revenue on tax credits."

In practice, the childcare vouchers scheme itself is relatively straightforward, though the Revenue says it does not have figures on how many employers are offering the scheme.

Assuming your company has signed up, you can opt to swap up to £50 a week of your salary in return for childcare vouchers worth the same amount. There is no tax or National Insurance to pay on the vouchers, so you end up better off paying for childcare this way than if you do it out of your take-home pay.

The only rule is that the vouchers must be used to pay for registered or approved childcare. This includes an Ofsted-registered childminder or nursery, a local authority-backed out-of-hours club, or a scheme run by a registered daycare provider. However, parents whose children are looked after by relatives or family friends miss out, even if they pay for the care. More positively, both parents can claim vouchers, however much they earn.

As the table (below opposite) shows, the gains can be significant. A couple who are earning a joint income of £50,000, for example, would usually have take-home pay of £716 between them each week.

After giving up £100 of salary before tax – £50 each – their take-home pay would fall to £649. But they then receive untaxed childcare vouchers of £100, taking the total back up to £749, or £33 more than they started with. Over a year, that figure amounts to £1,716 extra to spend on childcare. For parents on higher incomes, particularly if both are on the top rate of tax, the saving rises to more than £2,000.

However, the table does not include the effect on tax credits. Families with income of up to £58,000 may currently be able to claim at least some credits, depending on the size of their family and the amount they pay for childcare.

However, you can't claim tax credits on childcare costs that you have paid for with childcare vouchers – that would be double tax relief. And some families will lose more in tax credits as a result of this rule than they gain from the vouchers.

To add insult to injury, the Revenue has not yet come up with definitive guidance for parents to help them work out whether they will be better or worse off if they claim the vouchers. Parents researching the issue will find that the Revenue's internet site declares that such advice "will be added as soon as it is available".

Bull complains: "The Government is proving to be very slow in issuing guidelines that could help to clarify who the winners and losers will be in the childcare voucher lottery."

The Daycare Trust, an independent charity set up to help parents find out about their childcare options, says it is only possible to give a rough guide on who should claim what. Generally, parents who receive more than £545 a year in tax credits will lose out if they claim the vouchers. And, broadly speaking, if your childcare bills exceed £175 a week for one child, or £300 for two or more children, you'll be better off claiming the vouchers you need to pay the costs above these limits, the Daycare Trust says.

Nancy Platts, an adviser at The Maternity Alliance, another charity that works with parents, reckons the cut-off point for parents worried about losing out on tax credits is a household income of about £40,000. "There needs to be very clear guidelines from the Government and employers offering this scheme about who the vouchers are suitable for," she says.

Platts says the vouchers are generally good news for parents, but that uncertainty over who should be claiming the money could jeopardise the scheme.

High earners could lose out, too, warns Dan Ward, an adviser at the Daycare Trust. "If you are sacrificing part of your gross salary, it will have an impact on the size of mortgage for which you can apply, as well as on the private pension contributions you can make," he points out. This is because most mortgage lenders have restrictions on how much they will lend that are based on salary multiples – three times your annual pay is typical. If your pay is lower, so, too, will be the maximum you can borrow.

Similarly, the Revenue has restrictions on how much you can pay into a private pension as a proportion of your pay. If your salary falls, so does your contribution allowance.

Platts warns the pension problem could hit women particularly hard – and they are more likely to claim the vouchers than men. Women generally have less provision for retirement, she points out, so they can ill-afford to reduce their scope to make the highest possible pension savings.

One final problem is that sacrificing lower pay could mean you end up with lower benefits. Your entitlement to statutory maternity pay and sick pay from an employer, for example, often depends on your average pay, excluding childcare vouchers. So it could fall.

Similarly, state benefits such as the basic state pension, incapacity benefit and Jobseeker's Allowance depend on you having made sufficient National Insurance contributions, which childcare vouchers could affect. Again, women could suffer, as years out of work bringing up children will damage their National Insurance payments record.