If you are a parent, then you know that child care can be expensive. In fact, it is often one of the biggest expenses that families face. That’s why it’s important to start saving for child care as early as possible. In this blog post, we will discuss the best way to save for child care. We will also talk about FSA tax credits and how they can help you save money on your child care expenses.
Costs With Child Care
The sticker shock of daycare, babysitting, or a part-time child care program can cause many parents to panic. Regardless of income bracket, the fact is clear — child care is expensive.
The average annual cost of center-based infant care in the U.S. is nearly $16,000, according to a 2021 study by the Center for American Progress. This amount accounts for more than 16 percent of median married-couple family income — well above the Department of Health and Human Services’ (HHS) recommendation that child care should cost no more than 7 percent of household income.
The cost of child care has a significant impact on my family, as well as many of the families I work with as a financial planner. For some of us, child care expenses are equal to carrying a second mortgage month to month.
How to Prepare
Families each plan for the financial stress of child care in their own way. Some parents choose to have one of them stay home full time with kids who aren’t in school yet because it actually costs less than having a dual income household that pays for full-time child care. Other families save in advance for child care expenses or look for lower-cost solutions, such as an in-home daycare, care from relatives, or a cobbled together schedule of drop-off programs, babysitters, and flexible work arrangements that allow partners to tag team and simultaneously work/care for their kids. Since the Covid-19 pandemic began, many families have also had to balance working at home with kids — a situation that is unlikely to change in the near future.
When my husband and I decided it was time to grow our family, we immediately started budgeting and saving for child care costs. We also got appropriate insurances in place, like term life insurance, while we were young and healthy to help save on costs. While this helped to offset the costs, we now have two little ones with full-time care, and the monthly expense adds up quickly! No matter which way you look at it, the cost of child care often sparks some tough financial decisions for a family.
Saving ahead of time helped put a dent in our upfront costs, but we also had to take a close look at how child care fit into our lives, and we use ongoing financial planning strategies to reduce the impact that those expenses have on our family’s budget.
How to Budget
Two of the strategies that many families might consider to help cover the cost of child care are using a Dependent Care Flexible Spending Account (FSA) and taking the Child Care or Dependent Care Tax Credit. Families can only opt to use one option, and you may need to crunch some numbers or speak with a financial advisor to figure out which option makes the most sense for your family.
What is FSA?
A Dependent Care FSA is an employer-sponsored, pre-tax account. You set up automatic deductions from your paychecks that are contributed to this account and are eligible to use those funds for qualifying child care expenses. For the 2021 tax year, the maximum annual contribution was increased to $10,500 per household as part of the American Rescue Plan Act of 2021 (ARPA). In 2022, the maximum contribution dropped back down to $5,000 per year, per household. Even if both you and your spouse have a Dependent Care FSA available through your individual employers, you can only contribute up to the annual maximum to one or both accounts.
Child Tax Credit
Qualifying for the Child Care and Dependent Care Tax Credit requires that you:
- Have work-related expenses for child care. Basically, child care has to be necessary so that you can work. To prove this, the government requires that both parents provide proof of income. The exception to this rule is if a spouse is disabled or a full-time student.
- The care has to be for qualifying kids, 13 years old or under. A spouse or dependent who lives with the taxpayer for more than half the year and is either physically or mentally incapable of caring for themselves also qualifies.
- There is a limit to how much the credit is worth — up to 50% of qualifying child care costs for couples earning $125,000 or less. This percentage shrinks as your income increases over that amount.
Thanks to ARPA, the 2021 tax credits became more generous than usual. For the 2021 tax year, households can claim up to $8,000 in child care expenses for one child and $16,000 for two or more children. The credit starts at 50% of qualifying child care costs for households earning up to $125,000, and goes down to 0% for anyone earning $438,000 or more.
In 2022, the Child Care and Dependent Care Tax Credit will revert to 35% of up to $3,000 in child care expenses for one child or $6,000 in child care expenses for two or more children. As before, the percentage of child care expenses you are allowed to claim goes down as your income goes up.
Thanks for reading!