In my last post I talked about the various accounts we make use of that allowed us to stash away $95,750 tax advantaged dollars in 2017. We discussed 401ks, Roth IRAs (of the baby backdoor and megabackdoor varieties) and HSAs.
There are two more tax advantaged accounts that we make use of, but I don’t lump them in the same bucket as the others. These accounts give us tax advantages, but they differ from the other account types in that they don’t allow us to accumulate wealth in the accounts over time.
If the HSA is the well-known Alec Baldwin, in today’s post we’ll discuss its less known, also-ran brothers: the dependent care FSA and the limited purpose FSA.
The Dependent Care FSA (DCFSA)
If you choose to be parents, and if, like us you are a double income household with no family within a thousand miles, you will quickly discover that child care is the Goliath to every other David-sized expense that you will incur.
You can save on toys by offering your child Amazon shipping boxes and wrapping paper instead. You can clothe your child in hand-me-downs (or even for free courtesy groups like Buy Nothing). Small kids don’t cost much, with the one giant exception of daycare. Hand-me-down Nannies aren’t cheaper. There is no Sam’s Club of daycares.
In our stratospherically expensive area we had to shell out $1,900 a month for infant childcare. Now, at the age of three, that has dropped to a mere $1,300 a month. After our mortgage, this is our single largest monthly expense. In addition to the monthly fee there is an annual enrollment fee and a summer fee. We make Toddler BITA work it off as best she can. She is getting pretty damn good at taking out the recycling on garbage night.
Enter stage right our knight in shining armour: the Dependent Care FSA (DCFSA) to the rescue.
The DCFSA allows us to put away $5,000 a year in pre-tax dollars to be used for eligible childcare costs. The $5,000 limit is if your filing status is Married Filing Jointly. If you file as Single, you get $2,500.
How is your DCFSA funded?
Our DCFSA is funded via regular paycheck deductions. We do not have the option to frontload our contributions, or to make a lump sum contribution. The amount that we elect to put away in the DCFSA is taken out in 26 equal instalments.
How much do you save with a DCFSA?
The amount you save will depend on your marginal tax bracket. Like their handsome older brother, the famous HSA, DCFSA funds are also exempt from FICA (i.e. social security and medicare) taxation.
If for example, you are married filing jointly and in the 28% federal tax bracket and pay 9.3% in state taxes you will save:
- 28% of $5,000 in federal taxes. This is $1,400.
- 9.3% of $5,000 in state taxes. This is $465.
- 7.65% on FICA taxes. This is $382.5.
That gives you a grand total of $2,247.5 on $5,000 or 44.95%. Not too shabby.
So if you can keep your childcare expenses in the $5,000-ish range for the year, this is a Very Good Deal. For those of us spending in the $15k-$20k range, the discount is a lot less impressive but something is always better than the sad alternative.
What can you use DCFSA funds for?
We use the DCFSA to pay for Toddler BITA’s daycare (now preschool) costs. Here is a non-exhaustive list of categories covered by the DCFSA:
- Cost of a babysitter, if the babysitting was required for work related purposes (so babysitting because you went for a job interview is ok, babysitting for date night is probably going to make the IRS get grumpy).
- Extended care (like a supervised program before or after regular school hours).
- A nanny.
- Summer day camp.
In addition to the the expense being a ‘qualified’ expense, your child must be younger than 13.
I believe that the DCFSA may also be used to pay for the care of other dependents (like a spouse who cannot work, or parents), but I have no experience with this usage of the DCFSA.
How do you claim the money?
You reimburse yourself for eligible expenses from your DCFSA account.
Make sure you keep receipts of all eligible payments that show the date of payment, the name of your dependent, the amount, the care provider’s name, address and tax information. Credit card statements or pictures of cheques do not constitute valid proof in case the the IRS comes knocking.
At tax time you will fill form 2441 to claim this benefit correctly.
Dependent Care FSA Gotchas
There are a few things to be aware of if you choose to use a DCFSA:
- The money is use-it or lose-it. If you don’t end up spending the money on eligible childcare expenses, you can wave the money good-bye. Any unused money will not rollover from year to year. We are currently spending in excess of $15,000 a year on preschool, so we aren’t worried about being able to claim $5,000 over the course of a year. Even if say one of us got laid off and was at home for some months of the year unexpectedly, chances are still high that we will be able to claim the $5,000.
- Once you make an election to participate (during open enrollment), barring life-changing circumstances, you cannot change your mind or your amount of contribution during the year.
- The account is not pre-funded. You may spend at a rate higher than the rate at which the money accrues in the account. In other words, you should be in a position to pay for the expense out of pocket, and then reimburse yourself at a later date.
The Limited Purpose FSA
A limited purpose FSA (LPFSA) is a special kind of FSA that can be used in conjunction with an HSA. Normally, the IRS allows you to have either an FSA or an HSA for medical expenses, but not both. The LPFSA is an exception. You are allowed to have both an HSA and an LPFSA, if your employer deigns to offer it.
The LPFSA can be used for vision and dental related expenses. We are also allowed to use our LPFSA for medical expenses once we reach our deductible, but YMMV because whether or not this is allowed is entirely up to the nitty-gritty details of the plans that your employer offers.
The LPFSA allows us to put away pre-tax dollars for medical and dental expenses we expect to have in the year.
Here is a non-exhaustive list of things we can cover using our LPFSA funds:
- Dental plan co-pays and co-insurance
- Fillings, root canals, x-rays
- LASIK surgery
- Contact lenses and solution
- Prescription sunglasses
The LPFSA is also use-it or lose-it (though some employers may allow you to carry over up to $500 from one year to the next OR give you a grace period till Mid-March of next year to spend the money), so do some careful math depending on the health of your teeth and eyes to decide how much you should put away. The limit in 2017 is $2,600 per person. Based on our projected needs, we put away $1,400 in this account this year.
They Aren’t Alec, But…
Clearly the DCFSA and the LPFSA have nothing on the splendour and the wonder of the HSA. Nevertheless, they do bring some solid value to the table. If you qualify, take advantage of them. You should pay all the taxes you owe, but you should certainly not give the IRS anything you could put towards your FIRE stash instead.