If you have a child in daycare or if you’ve started researching the cost of it, you’ve probably experienced some stress in finding quality child care that is affordable. Child care costs depend on many factors, and even though there are things you can do to save money, working parents still spend thousands of dollars each year for child (or dependent) care.
If offered by your employer, one way you can save money is by using a Flexible Spending Account or FSA. There are two different kinds of FSA’s. A Health Care Spending Account for eligible out-of-pocket health-related expenses and a Dependent Care Spending Account for qualified care expenses.
Why Enroll in a Flexible Spending Account for Dependent Care?
You might be thinking that you are too busy to manage another account and it isn’t worth your time and the hassle it takes to set one up. While it is true that there is some paperwork required, the savings will be well worth the hour or less it takes to make sense of the requirements and fill out the forms!
You make contributions to Dependent Care FSA’s with pre-tax dollars, so you are not paying federal, state, Social Security, or Medicare taxes on the amount you put in your account. This reduces your adjusted gross income (AGI) for tax purposes. The average FSA participant pays 30% less in taxes vs. paying for care without an FSA. Try out this calculator to see what you would save!
What Does an FSA Cover?
Childcare including day care, nursery school, preschool, before and after school care, and nanny expenses are usually eligible expenses. Summer day camp is also an eligible expense in most situations.
If you have an older child, spouse, relative, or another dependent who lives in your home and is incapable of self-care, adult day care is generally eligible too. Always make sure to check with the administrator of your account to determine eligibility and necessary documentation.
How Do I Sign Up?
You can’t sign up for an FSA if your employer doesn’t offer it as an employee benefit. But many companies do provide them, so it is important to check. Talk to your supervisor or to the human resources director to determine your eligibility. They should also be able to answer any questions you have and provide you with the required paperwork.
If you have just learned about FSA’s or you’ve just decided to take advantage of this benefit, it’s important to note that there are restrictions on when you can enroll. The open enrollment period identified by your employer is when you can start an account unless you meet certain exceptions known as “permitted election change events.” Check with your employer to determine eligibility for a mid-year enrollment change.
There are also rules about who can sign up for this type of FSA if you are divorced. The custodial parent or the parent with the higher AGI (for parents with 50/50 shared custody) can elect the Dependent Care FSA per IRS regulations. If you are divorced or separated, it is essential to check with your lawyer and employer to determine who is eligible to use this benefit.
How Much Can I Contribute?
You can contribute up to $5,000 a year in a Dependent Care FSA if you file as single, head of household, or as married filing a joint return. If married and filing separately, you can contribute $2,500. This is assuming that you have earned an income of at least the amount you plan to contribute.
How Does the FSA Work?
You determine the total contribution and that amount is then deducted over a series of paychecks. You pay for care for your dependent like you usually would, and then you submit qualified expenses for reimbursement from your FSA. This typically requires a reimbursement form, a receipt for the care received, and the dependent care provider’s tax identification number. It’s important to remember if you have a family member or friend caring for your child that you will be reporting this claim to the IRS.
Are There Any Drawbacks?
Some people don’t like the paperwork involved or struggle with organizing receipts. But when they understand how much money they’ll save, they usually decide it is worth the effort. Others struggle living paycheck to paycheck and are worried about paying out money and having to wait for reimbursement.
Another problem is that you must use all the money in the account each year or you lose it! This isn’t a problem for most people who have full-time care for a dependent, but miscalculations can definitely cost you money.
What About the Child Tax Credit?
There are rules surrounding the qualification for this tax credit. In general, if you or your family earns more than $43,000 per year you may save more money with an FSA than with the child tax credit. The more you earn, the more likely an FSA makes sense as a way to save on the taxes you will have to pay.
Low-income earners and their families may benefit more from the tax credit. And some people can actually take advantage of both an FSA and the tax credit. But keep in mind that you can’t use the same expenses for both tax breaks. You can read more about the child tax credit and changes to the credit based on the Tax Cuts and Jobs Act here.
Discuss your options with your tax professional or try out calculators like these from Payflex to help determine what option might save you more money.
Final Thoughts on Dependent Care FSA’s
Contributing to a Dependent Care Flexible Spending Account is a smart decision for many people who have to pay for daycare. If you meet the requirements for an FSA, have eligible care expenses, and have considered your income and tax situation, an FSA is a great way to save on care for your child or loved one.