How do childcare vouchers work?

Childcare vouchers are part of a government-based initiative to help working families with the cost of their childcare.

If either you or your partner are employed, then there's a chance that you could be able to save some quite significant sums of money by joining a childcare voucher scheme.

The basic principle is that you make a 'salary sacrifice' to your employer for the provision of the vouchers. The money is deducted from your salary and you get vouchers in return, which you then can use to pay for your childcare.

There are four main parities involved:

• You
• Your carer
• Your employer
• The company that administers the scheme

The government is not involved in the day to day running or administration of the scheme. That is left to a number of private companies who provide and manage the voucher system.

What it means for you – some example figures

You benefit because the money is deducted from your gross salary before tax and National Insurance (NI) are taken off.

Let's consider a very simple example. If you pay tax at the basic rate of 20% and around 10% for NI, then for each £100 you earn the government takes around £30 and you get £70. So your £100 earned could buy you in effect, only £70 worth of childcare.

If you used £100 to buy childcare vouchers on the other hand, your employer would deduct £100 from your salary but you would get the full £100 worth of vouchers in return. So you would be able to buy £30 more childcare.

The maximum amount you can currently spend on tax vouchers is £55 per week or £243 per month. If your partner is also working they can buy this amount too. If you are both basic rate taxpayers then you and you partner could both save around £75 per month. That's £900 per year each.

At the moment 40% tax band payers can save a bit more- £99 per month or £1195 per year. From April 2011 however this saving will be reduced in line with basic tax rate rates.

Your employer

The employers who take part in these schemes don't lose out. This is because there are two 'sides' to NI contributions - those paid by employees and those paid by the employers. The amount your employer pays in NI is determined by the amount you are paid. Your 'salary sacrifice ' means that you are in effect being paid less so your employer pays less NI.

Administering companies

The companies who manage the schemes are generally Internet based. They act as an intermediary between you, your employer and your carer. Most if not all can provide paper vouchers but their preferred payment method is electronic.

Once you are registered with them your employer automatically credits your account. You can then either make online electronic payments straight to your carer's bank account yourself or set up standing order payments which will pay the same amount each time.

If your employer does not currently operate a voucher scheme you can ask them to do so. Just speak to your HR department. The companies who administer the systems are only too happy to contact employers on your behalf or provide you with documentation that you can give your employer about the scheme.

Carers

Childcare vouchers can be used for most forms of childcare - nursery, after school clubs, nannies, child minders, au pairs etc. You can only use vouchers for officially registered carers though. Relatives who take care of your children in your home do not qualify.

Carers have to register with the company administering your vouchers. This ensures that they are officially registered and allows them to cash in their vouchers. .

Things to look out for

Your salary sacrifice is not simply just another deduction from your salary. It actually means that you are agreeing to a form of change to your terms and condition of employment. You ask to be paid less in cash and get the vouchers in return.

From your point of view you are obviously getting the same amount of money but some official bodies may not take the voucher amount into account and will use only the reduced amount in their calculations using your salary.

Pensions

You may want to check with your occupational or private pension provider that your salary sacrifice would not have a negative effect on your pension.

Maternity pay

If you are pregnant, it's best to opt out of the scheme during your 8-week qualifying period (when your average salary is used to determine the level of your maternity pay) starting round week 17. Opt back in when the qualifying period ends.

Tax Credits

If you already receive tax credits then you may need to do a bit of checking to make sure that you would not end up worse off if you used vouchers as well.

For example, if you get child tax credit and currently spend £200 on childcare, your credit could be £160 (80% of £200). If you decide to use £100 of vouchers this would not be included in the calculation for your credit, which would reduce to £80. HM Customs and Revenue have an online calculator where you can key in your own details and find out whether using childcare vouchers would be leave you better or worse off.