When I was a little kid, day care was known as grandma’s house. When I got a little older, before and after school care was at one of my sets of grandparents’ houses as well. That’s where my sister and my cousins and I would go after school to get a snack and play until our parents got off of work and were able to pick us up (I don’t seem to remember too much homework getting done there). I’m pretty sure I’ve never spent a day of my life in a day care facility or preschool or before/after school care (besides at grandma’s, of course). Unfortunately, this isn’t an option for most people and preschool, day care, and before school and after school care are all expensive. Really expensive. If you pay for dependent care so that you can go to work and earn an income, then there may be an option offered to you through your employee benefits to lessen the sting of paying for those expenses. Although I wrote about the Dependent Care Flexible Spending Account (FSA) earlier this year, I’m going to freshen it up for this employee benefits series to keep it top of mind.
What Is A Dependent Care FSA?
Tell me if this story sounds familiar:
You’re a 30-40-something-year-old married couple with 2 kids, daycare expenses or before and after school care expenses, and have solid employee benefits packages, but you’ve never heard of the Dependent Care FSA. Let’s change that. If your life sounds like something along these lines, then this is one of the most beneficial employee benefits that you have available to you. Too many people aren’t being educated on the value of this tool and how it can help them.
First, let’s be clear – a Dependent Care FSA (DCFSA) is an employee benefit offered to you by your employer that you can sign up for during open enrollment or when you have another qualifying event. If your (or your spouse’s) employee benefits don’t offer a Dependent Care FSA, then you’re out of luck. Most people know what a more traditional Health Care FSA is, but I find that many people who should be taking advantage of a DCFSA and have it available to them through work aren’t.
The Dependent Care FSA allows a married couple who files a joint tax return to contribute $5,000 pre-tax to the account ($2,500 for single filers and those married but filing separately) that they can reimburse themselves from for qualified dependent care services such as day care, preschool, and before and after school care expenses. (You can find a full list of eligible expenses as determined by the IRS here). Day care expenses are equivalent to a second mortgage for a lot of people and having the option to pay for these costs pre-tax could be a huge benefit.
One caveat is that these dependent care expenses must allow you (and your spouse if you file a joint tax return) to work. Otherwise, you’re not eligible to take advantage of this benefit.
Who Is A Dependent?
According to the IRS, a qualifying dependent is your child who is under 13, a spouse who can’t care for himself or herself, or another dependent adult who you can claim as a dependent on your income taxes who can’t care for themselves.
Tax Benefits
The Dependent Care FSA lets you pay for $5,000 of qualifying dependent care expenses with tax-free money. An added bonus is that you get to contribute money to the account pre-FICA tax – that’s a benefit that you don’t even get through your employer-sponsored retirement plan.
Consider the example of a married couple who is in the 24% marginal Federal tax bracket. If they were to incur $5,000 of dependent care expenses in 2020 and contribute $5,000 to a Dependent Care FSA, then they’d save $1,582.50 in taxes ($5,000 x 24% Federal tax + $5,000 x 7.65% FICA tax). Some states may also allow you to deduct these contributions on your state tax return which could result in additional tax savings.
How Does It Work?
First, you want to make sure that you’ll have qualifying dependent care expenses in 2020 and figure out the amount. Assuming you’ll have to pay $5,000 in day care expenses so that you and your spouse can work, you can elect to have the money contributed to a DCFSA pre-tax by being withheld from your paycheck over the amount of times you’re paid in a year. So, if you’re paid monthly, you’d contribute $416.67 per pay, 24 pays would be $208.33 per pay, and 26 pays would be $192.31 per pay.
Next, you pay for your dependent care expenses as you usually would out-of-pocket and apply for reimbursement through your DCFSA provider by submitting an invoice. Many companies allow you to setup monthly reimbursements while you can also elect to just reimburse yourself one time once you’ve paid $5,000 in dependent care expenses.
Even if you haven’t contributed $5,000 to the account yet, many employers often will allow you to still receive a full reimbursement since the contribution from your pay will still be made with every paycheck throughout the year. If you were to quit your job, then you’d be responsible for paying back the outstanding balance.
The Downsides
While there are many great benefits of using a Dependent Care FSA, you should also be aware of the potential disadvantages. Just like a traditional health care FSA, if you don’t use the money that you contribute to a DCFSA, then you lose it. So, if you elect to contribute the married filing joint maximum of $5,000, but you only incur $4,000 of dependent care expenses, then you’d forfeit the remaining $1,000.
Another potential disadvantage of using a DCFSA is that your election will be locked in until open enrollment next year unless you have a qualifying event. Once you decide how much you’re going to contribute to the account when you make your employee benefits open enrollment elections you won’t be able to change that until open enrollment the next year, unless you have a unique circumstance that allows you to do so.
Depending on the employee benefits company that your employer uses and how they operate, it could potentially take a while to get reimbursed. Obviously, some providers are better than others and this will be a case-by-case basis.
Guide to Employee Benefits Open Enrollment 2019
The Dependent Care FSA is a great resource available to many people to help with extremely expensive dependent care costs. If you have to pay for day care, before or after school care, or any other qualifying cost in order to be able to work and earn an income, then you should be taking advantage of this account if it’s available to you through your employee benefits.
This is part 5 of a series where I’m providing general education on many of the employee benefits elections that you’ll be faced with during the 2019 employee benefits open enrollment season. Find the previous posts here:
