Contributing a maximum of $5,000 to a Dependent Care Flexible Spending Account (DCFSA) can make childcare more affordable.
A family with a combined federal and state tax bracket of 30% could save $1,500.
However, a DCFSA has a downside: the use-it-or-lose-it rule. If your spouse is not working, you risk losing up to $5,000.
The DCFSA has an alternative: the Childcare Tax Credit (CTC). Some families could save more without risking money.
The DCFSA favors higher dual-income earners with one child in daycare. In comparison, the CTC favors lower dual-income earners with two children in daycare.
Learn how these factors dictate your decision.
Spouse Stops Working During Plan Year
Contributing the maximum of $5,000 to a Dependent Care FSA often makes sense during open enrollment, even if you or your spouse might stop working in the future.
IRS rules provide special provisions. Couples with one child benefit the most.
Retirement
If your spouse retires, you can change your DCFSA contribution during the plan year. But remember, Social Security benefits do not qualify as earned income.
Grandparents raising grandchildren can use DCFSA funds for childcare if it helps both grandparents work. Plan your retirement after earning at least $5,000. This way, you avoid losing contributions.
Maternity Leave
You can change your DCFSA contributions during maternity leave if one or both spouses stop working to bond with their newborn. However, you may not want to resume contributions once both parents resume working.
Many couples find the main advantage of DCFSA contributions disappears after maternity leave ends. Having a second child in daycare doubles the value of the CTC.
| DCFSA Max | CTC Max | |
|---|---|---|
| One Child | $5,000 | $3,000 |
| Two Children | $5,000 | $6,000 |
Maternity leave pay does not count as earned income, so plan accordingly. If the mom chooses to stay at home, you could risk a portion of your DCFSA contribution.
Job Loss
You or your spouse could suffer an unexpected job loss during the plan year. The DCFSA rules vary if the employee or spouse is the one affected. The termination reason (layoff, fired for cause, resignation) does not matter.
- If the employee stops working, DCFSA contributions end. You can submit qualified expenses until the plan year ends.
- If the spouse stops working, the employee can change DCFSA contributions. You can submit qualified expenses until the plan year ends.
Spouse Not Working During Open Enrollment
Contributing the $5,000 maximum into a Dependent Care FSA rarely makes sense when your spouse is not working during the open enrollment period. The future is uncertain.
The risks of losing $5,000 outweigh the rewards frequently. The Childcare Tax Credit (CTC) is often safer when your spouse is searching for work, is a full-time student, or is incapable of self-care.
Actively Searching
You can use DCFSA funds to pay for childcare while your non-working spouse actively seeks new employment. However, you could lose the entire $5,000 if your spouse does not find a job and has no earned income during the year.
Earned Income
Your spouse must have earned income during the year for the expenses to qualify for DCFSA reimbursement. These sources count as earned income:
- Wages, salaries, tips, other taxable employee compensation
- Net earnings from self-employment
- Nontaxable combat pay
- Strike benefits
- Disability pay you report as wages
These sources do not count as earned income:
- Pensions and annuities
- Social Security retirement benefits
- Workers’ compensation
- Interest and dividends
- Unemployment compensation
- Scholarships or fellowship grants
- Nontaxable workfare payments
- Child support payments received
- Income of a nonresident alien
No Employment
A married employee’s DCFSA benefit limit is based on the lower-earning spouse’s earned income. You risk losing your total contribution if your spouse remains unemployed for the year.
| Lowest Earning Spouse Income | DCFSA Benefit Limit |
|---|---|
| $5,000 | $5,000 |
| $2,500 | $2,500 |
| $0 | $0 |
Your DCFSA may include a 2.5-month grace period to use unspent funds. However, after a year of unemployment, the chances of your spouse finding a job in the next ten weeks are low.
While the CTC is also unavailable if your spouse is unemployed, it does not require you to bet on future employment during open enrollment.
Incapable of Self Care
You can use DCFSA funds to pay for childcare while your non-working spouse is incapable of self-care. However, deciding to contribute $5,000 during open enrollment has the same downsides as the previous examples.
- You risk a portion of your contribution if your spouse does not recover, resume working, and earn at least $5,000 during the next twelve months.
- Your income will be lower while your spouse is incapable of self-care, perhaps making the CTC the better option.
You can apply for social security disability if your spouse will be incapable of self-care for twelve months or longer. However, the payments will not count as earned income.
Full-Time Student
You can use DCFSA funds to pay for childcare while your non-working spouse attends school as a full-time student. However, your household income will be lower while your spouse attends school.
The CTC often saves more taxes than the DCFSA when your spouse is a full-time student. The CTC favors low earners, while the DCFSA favors high earners.
| CTC Adjusted Gross Income | CTC % | DCFSA Taxable Income | DCFSA % |
|---|---|---|---|
| <$15,000 | 35% | <11,600 | 10% |
| <31,000 | 27% | <$23,200 | 12% |
| >$43,000 | 20% | <$94,300 | 22% |
| <$201,050 | 24% |
