Daycare Costs Are Soaring. Using This Pre-Tax Account to Pay for It Can Save You Big

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KEY POINTS

  • A Dependent Care FSA can help you pay up to $5,000 of care costs, plus save you money at tax time.
  • Participants in this type of FSA can save up to 30% on care services.
  • Sign-up is through your employer during an open enrollment period.

When it comes to reducing the cost of dependent care, every little bit helps.

It's no secret that childcare costs in the U.S. consume considerable household income. According to World Population Review, the average cost of center-based care for an infant is $14,760 per year. While prices vary by region, one tool you may have access to will help offset the cost while saving money at tax time. It's called the Dependent Care FSA (DCFSA).

Eligible expenses

DCFSA funds are used to pay for eligible expenses like:

  • Daycare costs for children up to 13
  • Preschool
  • After-school programs
  • Before and after-school programs
  • Nannies
  • Au pairs
  • Summer daycare
  • Transportation to and from eligible care
  • Eldercare
  • Adult daycare

DCFSA cannot be used to cover school tuition, enrichment classes, hobbies, sleep-away camps, or tutors.

How it works

If you're employed by a company that offers DCFSA, you authorize it to withhold a specific amount from each paycheck. And because those funds are withheld before taxes are paid, your overall tax burden is reduced.

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Let's say that you earn $2,000 per week and authorize your company to withhold $100 per week to be used toward childcare costs. That means that instead of paying taxes on all $2,000, you're only responsible for paying taxes on $1,900.

The maximum annual contribution in 2022 and 2023 is $5,000 per household or $2,500 for married individuals filing separately. It's important to note that some employers will allow you to roll over up to $570 of unused funds into the following year. If you work for an employer who does not allow rollovers, the entire amount you've had withheld must be spent by the end of the calendar year, or you lose it.

To be eligible as a married person filing taxes jointly, you and your spouse must either be working or looking for work. There are two exceptions to the rule:

  1. Your spouse is physically or mentally disabled and lives with you for a minimum of six months each calendar year.
  2. Your spouse is a full-time student.

If either you or your spouse earns less than $5,000 per year, the IRS limits how much you can contribute to DCFSA. For example, if your spouse earns $3,500 annually, $3,500 is the most you're eligible to have withheld for care expenses.

Reimbursement

You're responsible for paying for dependent care out-of-pocket. You then complete a claim form provided by your employer and provide proof of payment. Your employee reimburses you for those expenses.

How to enroll

If you're interested in DCFSA, ask your employer three questions:

  1. Do you offer DCFSA?
  2. When does the open enrollment period begin and end?
  3. How often do you cut reimbursement checks?

Just as companies provide an open enrollment period for medical care, there is an open enrollment period for DCFSAs. Once that window is closed, you'll have to wait until the next open enrollment to get signed up.

However, there are exceptions. The IRS does not require you to wait for the next open enrollment period to sign up if:

  • Your marital status changes.
  • Your number of dependents changes.
  • A dependent fails to meet eligibility requirements.
  • You, your spouse, or your dependent moves.
  • The employment status of you, your spouse, or your dependent changes.
  • The cost of dependent care coverage changes.

It is unlikely that DCFSA reimbursement will pay the entire cost of dependent care, but it can certainly make it sting a little less. And any program that allows you to leave more money in your bank account is worth exploring.

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