Interaction of tax credits and childcare vouchers
Question, answers and examples for employees

Please note that in the questions and examples that follow the advice given in relation to childcare vouchers also applies where the employer directly contracts with a childcare provider, for example, to provide a place at a commercial nursery.

To find out more information about how tax credits can help you with your childcare costs you may find the following useful:

Will I be better off accepting childcare vouchers in return for a salary sacrifice or by claiming tax credits help towards my childcare costs?

This will depend upon your individual circumstances. Generally speaking, your family will be better off accepting childcare vouchers in return for a salary sacrifice if you can answer 'yes' to one of the following:

  • Your eligible childcare costs are more than £175 per week if you have one child or £300 per week if you have two or more children. In this case you will always be better off accepting childcare vouchers to cover your childcare costs above these limits.
  • You are receiving tax credits at the family element (£545 per year, or £1090 per year if you have a baby aged under one) or less and you are claiming for your childcare costs.

Your family will generally be worse off or, at best, no better off accepting childcare vouchers in return for a salary sacrifice if you can answer 'yes' to both of the following:

  • You are receiving tax credits of more than £545 per year (or £1090 per year if you have a baby aged under one) and you are claiming for your childcare costs.
  • Your eligible childcare costs are no more than £175 per week if you have one child or £300 per week if you have two or more children.

These are only general pointers and there can be exceptions to these rules. You should always base any decision you make on your particular circumstances.

I am a higher rate taxpayer. Doesn’t that mean I am bound to be better off accepting childcare vouchers in return for salary sacrifice?

Not necessarily. Some higher rate taxpayers (those who pay tax at 40%) may be better off receiving help with childcare costs through tax credits.

I have worked out it would be more beneficial for me to take the child care element of Working Tax Credit, but I am currently receiving childcare vouchers, what should I do?

You will need to talk to your employer about leaving the childcare voucher scheme that your employer operates. When you will be able to leave the scheme will depend on the terms and conditions of the individual schemes.

You should then claim the child care element of Working Tax Credit, provided you meet the qualifying conditions. For more information call the Tax Credits Helpline on 0845 300 3900 or Tax Credits.

Do I need to change my child’s childcare provider in order to take the child care element of Working Tax Credit instead of vouchers?

No. If childcare qualifies for childcare vouchers, then it will also qualify for the child care element of Working Tax Credit.

I am currently receiving tax credits and it would be more beneficial for me to take childcare vouchers, what should I do?

If your employer offers a childcare voucher scheme, you should notify your employer that you want to join it. Your employer will then give you a start date.

But remember, as childcare vouchers are not treated as being a payment by you for childcare, receiving childcare vouchers will reduce the childcare costs that your Working Tax Credit calculation is based on, even if you reduce your salary and receive childcare vouchers instead (salary sacrifice). You should notify HM Revenue & Customs (HMRC) within one month if you’re getting the childcare element of Working Tax Credit, and the vouchers reduce what you actually pay for childcare by £10 a week or more. Your award will only be reduced after the first four weeks of the reduction in costs. If you don’t tell HMRC about the change, or delay reporting the change, you could be overpaid tax credits which you will have to pay back.

Childcare Vouchers and Tax Credits

How they interact – examples

The following examples cover the interaction between tax credits and childcare vouchers (and also directly contracted childcare) up to 5 April 2010.

The examples cannot cover every situation and if you are in doubt you should seek further advice. (Please note that in all of the examples, annual tax credit entitlements are rounded down to the nearest pound. Therefore some figures may not add up due to rounding.)

If your employer offers you help to meet your childcare costs (e.g. through childcare vouchers), your entitlement to tax credits is likely to be affected. This is because you can only claim help through the childcare element of Working Tax Credit on childcare costs that you meet yourself. If your employer meets any of your childcare costs, even if your pay has reduced in return (a salary sacrifice) these costs do not count. See Example 1.

If you want more information on how tax credits work or to find out whether you are entitled to tax credits you may find Tax Credits useful.

Example 1:

  • Kate’s childminder fees are £120 per week.
  • Her employer gives her £55 a week in childcare vouchers to use towards paying the fees.
  • The amount of childcare Kate pays for herself is therefore £65 per week (£120 less £55).

If your pay has reduced in return for an employer-provided childcare benefit such as childcare vouchers, your family income may also have reduced for tax credit purposes. See Example 2.

Example 2:

  • Denis earns £255 per week and has childcare costs of £105 per week.
  • He agrees with his employer that he will take £55 a week in childcare vouchers instead of cash pay.
  • Denis’s earnings therefore reduce to £200 per week (£255 less salary sacrifice of £55)
  • The amount of childcare he pays himself reduces to £50 per week (£105 less amount paid for by his employer through childcare vouchers of £55).

You need to be clear about whether your employer is offering you the childcare benefit in addition to your normal cash pay or if they are offering it in return for a reduction in your cash pay or instead of a cash pay rise that you would have otherwise received.
If the childcare benefit is in addition to your normal cash pay and you haven’t been given the option to receive it as a cash pay rise, it will normally be beneficial to you to accept the benefit from your employer. See Example 3.

Example 3:

  • Lucy’s childcare at a local nursery costs £130 per week. She is on a low income and therefore is entitled to the childcare element of Working Tax Credit as well as Child Tax Credit - this provides help with 80% of her total costs through the childcare element of WTC. The value of this childcare element before Lucy’s total award is adjusted to reflect her income comes to £104 per week, the final amount of tax credits she gets depending on the level of her income.
  • Her employer offers her £30 a week in childcare vouchers in addition to her normal cash pay.
  • Lucy’s tax credit claim is revised to 80% of £100 (£130 less £30 childcare vouchers) giving her a childcare element £80 per week before her total award is adjusted to reflect her income.
  • The amount her employer pays of £30 is tax and NICs free and therefore goes wholly towards her childcare costs.
  • The reduction in the maximum amount of childcare element Lucy could get per week is £24 (£104 less £80) but Lucy saves £30 per week in childcare costs.
  • She saves an extra £6 per week (£30 less £24) by accepting the childcare vouchers.

If the benefit is offered to you by your employer in return for a corresponding reduction in your cash pay (known as a salary sacrifice) it is less easy to know if you will be better off or not. You may find that the amount you save by paying less tax and NICs is offset by a reduction in your tax credit entitlement (see Example 4 below).

How tax credits may be affected by employer-supported childcare such as childcare vouchers?

Example 4:

  • John’s family income is £25,000 per year. He earns £15,000 per year and his wife earns £10,000. They both work over 16 hours per week. John has one child, aged 2, his registered childcare costs are £135 per week
  • John’s family is currently entitled to CTC £2,785 and WTC £2,899 – total tax credit help of £5,684.
  • John’s employer offers him £55 a week of tax and NICs-free childcare vouchers in return for a reduction in his cash earnings of the same amount, £55 a week. The tax and NICs savings he would make over the year are £904.
  • John’s family income would reduce by £2,915 (53 weeks x £55) to £22,085 and the childcare costs he pays himself would reduce to £80 per week (£135 less £55 in vouchers). His family’s new tax credit entitlement would be CTC £2,785 and WTC £1,748 – total £4,533. His entitlement has reduced by £1,151 cancelling out all of the tax and NICs saving. He will therefore be better off not taking the childcare vouchers.

In Example 4, if John’s family income decreases then he is not required to inform HMRC of the change, but he may wish to notify changes of income to get any increased tax credits more quickly. He must notify the change in his qualifying childcare costs however, since you must always notify HMRC if your qualifying childcare costs decrease to nil or by £10 a week or more.

Example 5:

  • Julie is a single parent earning £42,000 a year. She has 2 children aged 4 and 6 and incurs childcare costs of £300 per week. She works 35 hours per week.
  • Julie is currently entitled to CTC of £5,022 and WTC of £3,133, a total of £8,155.
  • Julie’s employer offers her £55 a week of tax and NICs-free childcare vouchers in return for a reduction in her cash earnings of the same amount, £55 a week. The tax and NICs savings she would make over the year are £1487.
  • Julie’s income would reduce by £2,915 (53 weeks x £55) to £39,085 and the childcare costs she pays herself would reduce to £245 per week (£300 less £55 in vouchers). Her new tax credit entitlement would be CTC £5,022 and WTC £1,982 – total £7,004. Her entitlement has reduced by £1,151 cancelling out all of the tax and NICs saving. She will therefore be better off not taking the childcare vouchers.

In some circumstances, tax credit losses could be greater than the savings made through employer-provided childcare or childcare vouchers. This could happen if your employer offers you the choice of either a cash pay rise or employer-supported childcare. This is because increases in family income, e.g. through cash pay rises, up to £25,000 per year are ignored when calculating tax credit entitlement for the current tax year. See Example 6 below.

Example 6:

  • Pamela’s earnings (and family income) are £25,000 per year. She has one child and qualifying childcare costs of £140 per week.
  • She works at least 30 hours per week and is currently entitled to CTC £2,785 and WTC £3,107 – total £5,892.
  • Pamela’s employer offers her the choice of either a 3.5% cash pay rise (£875 gross / £604 after deduction of tax and NICs) or £20 per week of tax and NICs-free childcare vouchers (£1040 per year).
  • If she accepts the pay rise, for tax credit purposes her family income will still be treated as £25,000 for the current tax year, and her childcare costs remain as £140 per week so her entitlement will not change.
  • If she accepts the vouchers she will benefit by £436 (the full voucher value of £1040 less the net cash she would otherwise have received of £604). But her tax credits will have to be recalculated as although her family income is still £25,000, her qualifying childcare costs are now £120 per week (£140 less £20 vouchers). Her new annual entitlement is CTC £2,785 and WTC £2,275, a reduction of £832. So, overall she would lose £396 for this year by accepting childcare vouchers.

In Example 6, Pamela would be worse off by accepting childcare vouchers from her employer as her tax credit entitlement in the year will decrease by more than her tax and NICs saving. Her pay rise would no longer be disregarded from the following April so she may need to recalculate the position at a later date.

If your childcare costs exceed the tax credit limits of £175 per week for one child and £300 per week for two or more children, you will always gain from accepting childcare help from your employer on the amount that exceeds the relevant limit. See Example 7 below.

Example 7:

  • Henry’s family income is £46,000. He has one child and childcare costs of £230 per week. Both he and his partner work over 16 hours per week and his marginal rate of tax is 20% and his NIC rate is 11%.
  • Henry is entitled to family element of working tax credits of £547. (Please note: This figure is slightly higher than the statutory amount of £545. This is because we will calculate your entitlement on a daily basis, round this figure up to the nearest penny and multiply this by the number of days over which you are entitled).
  • He is offered childcare vouchers of £55 per week in return for a corresponding salary sacrifice of £55 per week.
  • For tax credit purposes Henry’s family income reduces to £43,085 (£46,000 less £2,915 – (£55 x 53 weeks). His qualifying childcare costs also reduce to £175 per week (£230 less vouchers of £55) but this does not affect his claim as the maximum that can be claimed is £175.
  • Henry’s revised entitlement to tax credits (because of his lower family income) doesn’t change and he and his partner are still entitled to the family element of working tax credits of £547. However, he also saves the tax and NICs he would have otherwise paid on his higher salary which comes to £904 per year.

Some families cannot claim help with their childcare costs through tax credits as they do not qualify for the childcare element of Working Tax Credit. This may be:

  • Two parent families where only one parent works;
  • Single or two parent families where one or both parents work less than 16 hours per week; or
  • Where the level of family income is such that only the family element of CTC is due. (A family may not be actually getting WTC but because the two credits are calculated together, with entitlement to one determining entitlement to the other, a family getting just CTC at more than the family element rate will still be in the position of the examples above rather than the example below).

In these situations, families with children can still claim CTC. The basic family element of CTC is due to all families with an income up to £58,000 per year.

These families will also always benefit from participating in employer’s childcare support or childcare voucher schemes. See Example 8 below.

Example 8:

  • Lisa is a single parent with one child. She earns £44,000 per year and works 35 hours a week. She has one child aged 6 and pays a nanny £175 per week. She currently receives CTC of £547 per year.
  • Lisa’s nanny becomes approved therefore is a qualifying child carer for the purpose of tax and NICs.
  • Lisa’s employer offers her childcare vouchers of £55 per week in return for a reduction in her cash earnings of the same amount, £55 a week.
  • Her salary is reduced by £2,915 (53 weeks x 55) to £41,085 and the childcare costs that she pays by herself would reduce to £120 per week (£175 less 55 in vouchers). Her tax credit entitlement remains unchanged, and so she will be better off taking childcare vouchers.
  • She saves the tax and NICs she would have otherwise paid on her higher salary. This amounts to £1474 per year.

Finally, if you decide to accept childcare support from your employer in return for a salary sacrifice you may be asked to sign up to your employer’s scheme for a period, for example 12 months.

Checklist

If your employer offers you tax and NICs-free childcare in the form of childcare vouchers, directly contracted childcare or a workplace nursery scheme, it is up to you whether you decide to participate in your employer’s scheme. HMRC recommend, however, that you follow this checklist before you sign up. You should also carefully read the terms of your employer’s scheme and make sure that you understand what the scheme is offering you.

1. Is the benefit on top of my normal pay or am I expected to give up salary/ forego a pay rise in return for it?

  • Ask your employer

2. How will my entitlement to tax credits be affected?

NB: they may be reduced as a result of entering an employer-supported childcare scheme.

  • Read this guidance

3. If my cash pay is reduced, how will my other earnings-related payments be affected (pension, overtime rates, pay rises etc)?

NB: whether these payments are affected will depend on your particular terms and conditions.

  • Ask your employer

4. If my cash pay is reduced, will my State Pension and other statutory benefits be affected?

NB: your entitlement could be reduced as a result.

5. If my cash pay is reduced, will my student loan repayments be affected?