Will you lose out in tax credit cuts?

Familes who receive tax credits to supplement their income could find themselves more than £1,000 a year worse off following cuts to the welfare budget.

The cuts, part of a government plan to reduce welfare spending by £12 billion, aim to reduce the tangle of tax credit payments described as "unsustainable" by Chancellor George Osborne. He said: "The original tax credit system cost £1.1 billion in its first year. This year, that cost has reached £30 billion. We spend more on family benefits in Britain than Germany, France or Sweden."

Others say the changes will hurt those on the lowest incomes, hitting women, large families and young people particularly hard. The Institute for Fiscal Studies calculates that the changes will leave some three million families up to £1,000 a year worse off.

So what are tax credits, how do they work and what do the changes mean for those who receive them?

What are tax credits?

Tax credits are intended to support people on low or moderate incomes. There are two types – the working tax credit and child tax credit. As their names suggest, they are paid to working people on low incomes and families raising children.

They were introduced by Gordon Brown during his first term as chancellor to ensure that people moving off benefits and entering work in low-paid roles or on a part- time basis did not end up with a lower income.

Tax credits have had a big impact. They are claimed by 4.5 million people, four million of whom have children. Since their inception, the number of children living in families below the poverty line fell from 35% of the child population in 1998/99 to 19% in 2012/13.

But as well as costing the taxpayer a lot of money, some people argue that they are a disincentive for people to increase the number of hours they work, or even take on a job at all.

How do they work?

You may be eligible for child tax credit if you have one or more dependent children.

Child tax credit claimants are paid the family element, a single flat-rate payment of £545 a year, regardless of how many children they have, plus an additional amount for each child, depending on the income the family receives from other sources. The maximum additional amount you can get in 2015/16 is £2,780 per child, although parents with disabled children may receive extra.

If you are only claiming child tax credit, this amount is reduced by 41p for every £1 you receive or earn in pre-tax income over an income threshold of £16,105.

To claim working tax credit, you must be working for at least 16 hours a week as a lone parent, disabled person or aged over 60, while a couple must jointly do at least 24 hours a week if they have children. Otherwise you can only qualify if you work 30 hours per week and are aged 25 and over.

Claimants receive a basic element, worth £1,960 in the 2015/16 tax year. They may also qualify for additional sums if they are part of a couple or are a lone parent, are disabled, working for at least 30 hours a week (if you are aged 25 or more) or pay for childcare.

As with child tax credit, for every extra £1 that you earn over the threshold, you will lose 41p of tax credit. The big difference is the level of the threshold - just £6,420. This applies to people claiming working tax credit on its own and those claiming both working tax credit and child tax credit.

Tax credit cuts

From 6 April 2016, the income threshold for working tax credits will be cut to £3,850, while the size of the taper will increase from 41% to 48%.

Most controversially, from April 2017 parents will only be able to claim child tax credit for two children, regardless of how many they actually have. The government has said this new rule will not affect families who already receive child tax credits.

In addition, people starting a family after April 2017 will not be eligible for the £545 family element of the tax credit.

The government says that the introduction of a new National Living Wage, combined with increases to the personal allowance (the amount of income you can earn without paying any tax), will offset the reduction in benefits.

Lee Healey, founder of IncomeMAX, a service that provides free financial advice to vulnerable and low- income families, says that some people, who will see their wages increase through the new National Living Wage, will potentially benefit. But people who already earn slightly more than the £7.20 initial rate, or those who are aged under 25, will not benefit from the new hourly rate and will not see an increase to their earnings to offset the tax credit cuts. Many will lose between £30 and £50 a week.

"The increase to the personal allowance does not nearly match the reduction in tax credits. If you do not benefit from a rise in your income because of the National Living Wage, you will really lose out through these changes if you are claiming tax credits," he says. "We've had lots of people get in touch about this - they are frightened about how they will keep their families finances going."

So how will the changes affect Sam?

Already earning £7.20 an hour, her income will now be assessed according to the new income threshold of £3,850 and a taper rate of 48%. She will lose £4,441.92 of tax credits, leaving just £6,443.

Sam's net salary will be £12,075 because of the increase in the personal allowance to £10,800 in the 2016/17 tax year. The net salary added to her tax credits will give Sam an annual income of £18,518 (not including child benefit). This leaves Sam and her children worse off by £1,624 a year.

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