ChristineH you haven't said how old the two children are - as long as they aren't really young there is no reason why your DIL couldn't work. However often the benefits she receives are often greater then a wage. Benefits often come with perks like Council Tax benefits, free school meals and free dental treatment for her. It's a really catch 22 situation. The Benefits Agency would have watched her home for some time after a tip off to ensure that she does have someone living with her. They don't just take a neighbour's word for it. I know you're worried about your grandchild but try not to give her any money but if you do insist she declares it to the Agency or you will - they will be interested to know she is getting extra money.
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