Under a government scheme introduced in 2006, employers are able to provide childcare vouchers up to the value of £55 per week to their staff free of tax and national insurance contributions, subject to certain restrictions.
Under the scheme, known as 'salary sacrifice', a worker agrees to give up part of their salary and to receive childcare vouchers instead, up to the equivalent value of the vouchers.
The saving on tax and national insurance provides a financial benefit but there can be disadvantages to families on low incomes and to parents who may rely on tax credits and state benefits that are based on paying national insurance contributions.
This briefing explains how salary sacrifice works in practice and identifies issues that parents should consider before signing up to a salary sacrifice scheme.
Many employers do provide vouchers through a salary sacrifice scheme but there is no requirement to do so.
Under a salary sacrifice scheme an employee agrees to give up a portion of their salary and to receive childcare vouchers instead. Your employer decides the limit on the amount of childcare vouchers they will provide, up to £55 per week.
You then have to sign a variation to your contract stating that you will accept childcare vouchers up to the limit set instead of salary.
You are then exempt from having to pay income tax or national insurance on the part of the salary that you receive in the form of childcare vouchers.
The amount of benefit will be the income tax and national insurance saved on the weekly value of the childcare vouchers which will depend on your earnings, and the percentage of income tax and national insurance you pay.
If your employer offers childcare vouchers under a salary sacrifice scheme, you are exempt from paying income tax and national insurance on that portion of your earnings. Howver, you should note that people who earn below the lower earnings limit for income tax (£90 per week from April 2008) do not benefit from tax savings.
Those who earn below the primary threshold for national insurance payments (£105 for 2007-8)) do not benefit from national insurance savings.
Accepting childcare vouchers reduces annual earnings so you need to be clear about how your employer will treat your salary (i.e. before or after voucher deduction) for the purposes of pay increases, allowance, shift payments, starting pay on promotion, maternity pay, sick pay and other pay-related conditions of service as well as occupational pensions.
This should all be made clear before you sign a contract variation to receive vouchers.
In the civil service, we have reached an agreement that employees should retain their notional salary (before voucher payment) for all-related conditions of service and for calculating pension contributions under the classic and premium pension schemes but this should still be made clear in the contract variation.
It is up to your employer how they treat the salary of an employee in receipt of childcare vouchers for pay and pension purposes so it is always wise to check this in advance.
Note that salary sacrifice must not bring your hourly wage below the minimum wage of £5.52 per hour (as from 1 October 2007)
The calculation of many state benefits, including the state pension, incapacity benefit, statutory maternity pay and job seekers allowance, is based on earnings-related national insurance contributions.
By not paying national insurance on the monetary value of childcare vouchers this may have an effect on entitlement to benefits. However, because the limit is £55 per week, the effect is not likely to be significant over a lifetime, unless you already has gaps in your contributions or your earnings are very low.
In accepting childcare vouchers under a salary sacrifice scheme, net salary - after the deduction of the value of the vouchers - should not fall below the lower earnings limit for income tax payment of £90 per week or state pension and benefits could be adversely affected.
Entitlement to working tax credit and child tax credit is unlikely to be affected by childcare vouchers, as registered and approved childcare costs are not a factor.
In fact, if your salary goes down, working tax credit may go up. Entitlement to the childcare element of working tax credit - which provides specific support related to childcare costs - will in most cases be affected.
If you are in this situation you should explore whether you are entitled to tax credits first before considering taking vouchers as it is possible that there is a greater benefit in tax credits than in voucher saving.
If you decide to accept childcare vouchers under salary sacrifice and sign a variation to their contract, the agreement will usually be for a specified and renewable period of perhaps a year.
During this time, you do not have the right to change your mind and to revert back to a full salary payment but some employers may allow this in life-changing circumstances such as birth, marriage or death.
It is important to check this before signing a contract variation to receive vouchers, as some employers may be less generous about notice periods.
Where a salary sacrifice is set up, you may receive childcare vouchers exempt from tax and national insurance in respect of a child of stepchild you are wholly or partly responsible for, who is resident with you and who is a child for whom you have parental responsibility in law.
Note that in a two-parent family, both parents may quality to receive childcare vouchers through salary sacrifice.
To qualify for the tax and national insurance exemptions, childcare vouchers can only be used for registered or approved childcare but this can include out of school clubs and holiday play schemes.
Vouchers cannot be used to pay for informal childcare or to pay relatives for childminding. Your employer will be able to advise you what forms of childcare are covered.
In addition to providing childcare vouchers through a salary sacrifice scheme, employers may also choose to introduce schemes that allow you to benefit from income tax and national insurance exemptions on other forms of childcare support. These are:
People who receive childcare vouchers on top of their existing salary (salary plus), may also be exempt from income tax and national insurance contributions on the value of the vouchers up to £55 a week.
Where your employer operates a nursery of holiday play scheme, on their own premises or on premises provided jointly with others (but retains responsibility for financing and managing the provision) and provides subsidised places, the employee may be entitled to claim exemption from income tax and national insurance on the value of the subsidy. There is no limit on the value of the subsidy.
Where your employer pays a subsidy to a third party for providing a holiday play scheme or childcare facility for staff, the employee may be exempt from income tax and national insurance contributions up to the value of £555 per week.
To qualify for tax and national insurance exemptions, vouchers and subsidies must generally be available to all staff on the payroll at a particular location.
Note: all figures quoted are correct at April 2008, for any later changes to income tax, national insurance and earnings limits check the HM Customs and Revenue website
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