Is Universal Credit Better Than Tax Credits?

The introduction of Universal Credit (UC) has fundamentally changed the welfare system in the UK, replacing several benefits, including Tax Credits. Whether Universal Credit is better than Tax Credits depends on your individual circumstances, including your income, family situation, and employment status. Here, we explore the key differences, potential advantages, and disadvantages of both systems to help you decide which might be better for you.

What are Universal Credit and Tax Credits?

• Universal Credit is a comprehensive welfare payment introduced to replace six existing benefits, including Child Tax Credit and Working Tax Credit. It is designed to support individuals and families with low incomes, whether employed or unemployed. UC is a single monthly payment covering both living costs and housing assistance.

• Tax Credits are divided into two categories:

  • Child Tax Credit (CTC): Provides financial support to families with children.

  • Working Tax Credit (WTC): Helps individuals who are employed but on low incomes to boost their earnings.

While the tax credit system remains for existing claimants, most new applicants must apply for Universal Credit instead.

Key Differences Between Universal Credit and Tax Credits

1. Integrated vs Separate Benefits

• Universal Credit integrates several benefits into one monthly payment, which can include housing costs, child benefit, and support for disabilities.

• Tax Credits are separate from other benefits such as Housing Benefit and Income Support. This can mean dealing with multiple departments and payments, which can be more complicated.

2. Payment Frequency

• Universal Credit is paid monthly, designed to mimic a monthly salary and encourage financial independence.

• Tax Credits are usually paid weekly or every four weeks, which can help those who struggle to manage a monthly budget.

3. Income Assessment

• Universal Credit uses a real-time income assessment, meaning any changes in earnings are reflected in the next payment. If your earnings go up or down, your Universal Credit payment adjusts accordingly.

• Tax Credits are based on your income from the previous tax year, and changes are updated annually unless you report a significant change during the year. This delay can lead to overpayments or underpayments.

4. Benefit Tapering

• Universal Credit tapers off as your earnings increase, at a rate of 55p for every £1 earned above your work allowance. This makes the transition from benefits to work more gradual.

• Tax Credits have a higher withdrawal rate of 41p for every £1 earned over the threshold, meaning your payments reduce more quickly as you earn more.

5. Support for the Self-Employed

• Universal Credit has a minimum income floor for the self-employed, meaning if you earn less than a certain amount, your payment will be based on that floor, not your actual income.

• Tax Credits base your entitlement on your actual earnings, which may be more favourable for the self-employed with fluctuating incomes.

6. Childcare Support

• Universal Credit offers up to 85% of childcare costs for eligible claimants, which is higher than the 70% offered under Working Tax Credit.

• However, under Universal Credit, you must pay childcare costs upfront and claim them back, while Tax Credits provide childcare support in advance.

Advantages of Universal Credit

1. Simplified System: Universal Credit replaces multiple benefits with a single monthly payment, making it easier to manage your benefits in one place.

2. Flexible Payment: Real-time income adjustments mean that your payments reflect your current financial situation, avoiding overpayments and underpayments.

3. Improved Work Incentives: With a taper rate of 55p in the pound, you can keep more of your earnings under Universal Credit compared to Tax Credits.

4. Better Childcare Support: UC offers higher support for childcare costs, which can make returning to work more feasible for parents.

Disadvantages of Universal Credit

1. Monthly Payments: If you're used to receiving payments weekly or fortnightly, managing a single monthly payment might be difficult, especially if you are not used to budgeting on a monthly basis.

2. Real-time Adjustments: If your earnings fluctuate frequently, your UC payment will vary month to month, which could make it harder to budget.

3. Upfront Childcare Costs: Under Universal Credit, you need to pay childcare costs upfront and reclaim them, which could be challenging for low-income families.

Advantages of Tax Credits

1. Frequent Payments: Tax Credits are typically paid weekly or every four weeks, which can be more manageable for families with tight budgets.

2. Based on Annual Income: Tax Credits are assessed based on your income from the previous year, which provides more certainty for those with fluctuating incomes.

3. No Minimum Income Floor for the Self-Employed: Unlike Universal Credit, Tax Credits do not impose a minimum income floor on self-employed individuals, which may result in better support for those with variable earnings.

Disadvantages of Tax Credits

1. Higher Withdrawal Rate: Tax Credits taper off more quickly than Universal Credit as your earnings increase, which can create a steep financial cliff when you start earning more.

2. Overpayments: Because Tax Credits are based on your income from the previous year, changes in your circumstances could lead to overpayments that you have to pay back.

3. Separate Payments: Tax Credits do not cover housing costs, so you may need to apply for multiple benefits to cover your full needs.

Common Triggers for Moving from Tax Credits to Universal Credit

• Change in circumstances: If you move home, start a new job, or experience other changes in your financial or living situation, you may be required to switch from Tax Credits to Universal Credit.

• Natural migration: If you’re currently receiving Tax Credits and your circumstances remain the same, you may eventually be moved to Universal Credit under the government's ongoing transition to the new system. However, you won’t be moved until you're contacted by the Department for Work and Pensions (DWP).

• New claims: New applicants for financial support must apply for Universal Credit rather than Tax Credits, as the latter is closed to new claims.

Which is Better for You?

Ultimately, the decision on whether Universal Credit is better than Tax Credits depends on your personal circumstances:

• Low-income households with fluctuating incomes may prefer Tax Credits due to their more stable payment schedule.

• Working parents, particularly those with high childcare costs, may find Universal Credit more beneficial due to higher childcare support.

• Self-employed individuals might find Tax Credits more supportive, as there is no minimum income floor applied.

Conclusion

For some, Universal Credit offers a more streamlined, flexible system with improved work incentives and childcare support. However, others may find the more predictable nature of Tax Credits suits them better, especially if they have fluctuating incomes or prefer more frequent payments.

The decision between Universal Credit and Tax Credits depends on your circumstances, but with the eventual phasing out of Tax Credits, it's essential to understand how Universal Credit could impact you. Always consult with a financial adviser or contact the DWP or HMRC for advice tailored to your specific situation.