A Dependent Care FSA Can Help Parents Reduce Their Tax Load—Here's What to Know

It's no secret that starting a family is expensive, and for many, paying for childcare is a challenge. According to a 2021 analysis by the nonpartisan Center for American Progress, providing center-based childcare for an infant in the U.S. averages over $1300 per month. While the dependent tax credit provides relief for some, there's another way for parents to save money: Enter the dependent care flexible spending account (FSA).

FSA Basics

You may be familiar with a healthcare FSA, which allows account holders to arrange for their employer to set aside pre-tax money for medical costs. Well, a dependent care FSA works the same way but sets aside money for childcare—encompassing infant care through preschool, summer day camp, and before- and after-school programs—as well as adult care.

Everyone is eligible for this program as there are no income limits for opening a dependent care FSA, but each household can only contribute up to $5000 per year, regardless of how many kids it has. Like other FSAs, all money must be used within the year it was contributed. (That is, funds don't carry over from year to year.)

"We love dependent care FSAs," says Katie Waters, CFP, founder of Stable Waters Financial, a Georgia-based financial planning firm. "They allow parents to intentionally set aside money for childcare, while also saving money on taxes: If they reach the contribution limit, parents can reduce their taxable income by $5000 most years, saving a substantial amount on taxes."

How It Works

With a dependent care FSA, parents sign up at work for their employer to direct-deposit a portion of each paycheck into their dependent care account. Later, after parents pay for childcare expenses, they file for reimbursement of those payments up to the amount in their account. Waters encourages some clients to just file once a year for a lump-sum reimbursement, but families can opt to file monthly to get funds to pay for the next month's childcare.

Tax Savings

Because funds are distributed from paychecks pre-tax, contributions to a dependent care FSA reduce account holders' taxable income, helping parents save on taxes. In most cases, the $5000 contribution limit doesn't cover the entire cost of childcare, but saving anything on taxes is better than nothing.

If you chose to have a dependent care FSA, that doesn't preclude you from also having a healthcare FSA or even a health savings account (HSA). Contributions to each account are earmarked on your pay stub, so you can always track how much you've contributed to each.

The Downside

A key to maximizing tax savings is to remember to file on time. Dependent care reimbursements must be filed within the year in which they were contributed, and if you file late, you may lose those funds.

Also, scheduled contributions can't be changed without a qualifying event (such as a birth or adoption). Once you decide how much per paycheck you want to contribute to a dependent care FSA during the enrollment period (which you must do every year), you are tied to that amount for that year unless there's a change in employment or family size.

Not Just For Children

Dependent care FSA funds can also be used for adult daycare and other expenses related to caring for any dependent—not just children—such as a spouse who is unable to work and care for themselves or an elderly parent.