Dependent Care Flexible Spending Accounts are one of my favorite, yet lesser-known employee-benefit options. Child/Dependent care is expensive and a DCFSA can help ease some of the stress on the budget. It can be a great tool for young families, like my own, who will have a significant amount of daycare expenses in a given year.

So…what is it, how does it work, and why should you consider it:

What is a Dependent Care FSA?

It’s a voluntary employee benefit option allowed by some (but not all) employers to help you save money on your family’s child care expenses.

How does it work?

By saving from your paycheck into a Dependent Care FSA, you use pre-tax dollars to pay dependent care expenses. This allows you to shelter a portion of your child care expenses from Federal and State income taxation, and, in many cases, Social Security and Medicare taxation also. This helps to reduce your taxable income and, in turn, may reduce the overall amount of taxes you pay.

Benefits of enrolling?

Tax savings is the main reason for using a Dependent Care FSA. As an example, if you contributed the household maximum of $5,000 in a year and fall into the average household tax bracket (22% Federal, 5% State) for most Kentucky families, you might expect to save roughly $1,350 a year in Federal & State taxes alone and up to $1,732 if you include the Social Security and Medicare tax.
Drawbacks of enrolling?

Dependent Care FSA’s are “use-it-or-lose-it” accounts. The money you contribute each year cannot be rolled over into the next year. Families must be careful not to contribute more than they expect to pay in child care expenses for that given year.

Families must also be careful to keep good records/receipts of their child care expenses and also ensure that their child care expenses meet the qualifications for reimbursement (i.e. child care provided by someone outside of your family, etc.).

What you should consider before enrolling?

The first question to ask yourself is “will I be paying child care/dependent care expenses next year?”. If the answer is “yes”, it becomes important to start estimating how much you expect to spend in that year so that you prevent over-contributing to the account.

The final and more difficult question to consider is “will it be more beneficial to save into a Dependent Care FSA or take the Child Care Tax Credit?“. Unfortunately, that answer is beyond the scope of this post. While tax saving is important, it’s also important to consider how this decision fits into your overall financial plan. The decision to enroll or not enroll in a Dependent Care FSA should ultimately be made on an individual basis with the help of your CPA and/or financial planner. At the very least though, it should be part of the conversation.

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