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How Does a Dependent Care FSA (DCFSA) Work?

6 min read

30 sec brief

A DCFSA is a flexible spending account that allows you to set aside money from your paycheck, pretax, in order to pay for child or adult day care services that allow you to either work or look for work. In this article, we discuss how exactly a dependent care FSA works.

There’s no way around it, being a caretaker, whether it’s to a child (or multiple children) or an adult who can’t take care of themselves, requires balance in terms of time and finances. Especially if you also work. You can buy time by hiring a caretaker, but sometimes the cost of that outside help can be a barrier to working for some adults. If your employer (or your spouse’s employer) offers a Dependent Care FSA (DCFSA), this could help you save money on dependent care services. Let’s take a look at how a DCFSA works.

What is a DCFSA?

A DCFSA is a flexible spending account that allows you to set aside money from your paycheck, pretax, in order to pay for child or adult day care services that allow you to either work or look for work. These accounts can only be offered through an employer and you must sign up during your company’s open enrollment period. You must also use your funds by the end of the year or forfeit what remains. For more detail, check out our article: What is a Dependent Care FSA.

2020 DCFSA Rules Due to COVID-19

Due to the COVID-19 pandemic, the IRS has adjusted some rules for DCFSAs for 2020. The rule adjustments are as follows:

Plan participants can choose to start, stop or change contribution amounts outside of open enrollment, with employer approval. Your employer can elect to allow you to rollover a portion of unused funds to 2021, or your employer can elect to give you a grace period of up to 2 ½ months following the end of the plan year to use up remaining funds.

For information about what your specific employer is offering in terms of COVID-19 relief, contact your HR Department for more information about your specific plans.

How a DCFSA Works

The easiest way to describe how a DCFSA works is to walk through a real-life example. So let’s take Carlos and Nicole. They have two kids, ages 18 months and 3 years old and Nicole is getting ready to go back to work after taking time off to raise their young children. She needs to hire a babysitter or nanny for the 18-month old and is sending her 3-year old to preschool. Luckily, Carlos’ employer offers a DCFSA.

They know how much preschool costs them per month and roughly how much child care costs per hour in their area, so during open enrollment, they elect to set aside $416 per month from Carlos’ paycheck. This means they will contribute $4,992 annually ($8 shy of the $5,000 maximum contribution limit for 2020) and since they are in the 22% tax bracket, it also means they will save $1,098 over the course of the year in childcare and preschool costs.

DCFSAs are not prefunded, and while some employers will prefund employees’ accounts, paying back the contributions from future paychecks, Carlos’ employer doesn’t elect to do this. So, starting in January, when the plan commences, Carlos’ employer takes $416 from his gross pay (i.e. pretax) and deposits it into his DCFSA.

Also in January, Carlos and Nicole pay for preschool fees and for their nanny directly, the costs of which total $450. Then, they submit a claim to the DCFSA to be reimbursed for $416 of their costs. The required documentation includes:

  • The claim form provided by Carlos’ employer, completed.
  • A receipt from the preschool showing the fees amount as well as the date they were paid.
  • A receipt from the preschool showing the fees amount as well as the date they were paid.
  • A “receipt” from the nanny that includes the amount, date the expenses were paid, as well as his or her full name, social security number or tax ID and address.

Note: In order to get reimbursed for your childcare through a DCFSA you can’t pay your provider “under the table”. So you’ll need to communicate with them. Not only will they be required to claim their earnings on their taxes, but you might be subject to a payroll tax depending on how much you pay your nanny over the course of the year.

Once the expenses have been approved, the DCFSA administrator will send the reimbursement to Carlos and Nicole via direct deposit into their bank account. The DCFSA administrator also gives the option of receiving reimbursements via check mailed to their home. If Carlos and Nicole incur fewer childcare costs than they anticipated and end up overfunding their account, they will forfeit the funds that remain at the end of the year.

After electing to contribute $416 per month, Carlos and Nicole cannot make any changes to their DCFSA until the next open enrollment period unless they have a qualifying life event. These events include, but are not limited to: birth or death of a child, loss of employment, marriage, and divorce. If they do experience a qualifying life event, they must apply for a change to their DCFSA through their employer within 31 days of such an event occurring.

What You Can Use Your DCFSA Contributions For

As we saw in the previous example, you can use your contributions to pay for a babysitter, nanny, and preschool. Here are a few more examples of what you can use your DCFSA contributions to pay for.

Shonda’s mother is 76 years old and has dementia. Her mother lives with her full time so while Shonda is at work, she needs a caretaker to be with her mother during the day. Shonda can help pay for these day time caretaking costs by contributing to a DCFSA. What she can’t do is put her mother in a nursing home and pay for those costs out of her DCFSA.

It’s summertime and Stacy and Ryan’s kids are out of school, but they both work full time. They can use their DCFSA contributions to pay for summer camp and for a babysitter outside of summer camp hours so they can still work while their kids are out of school. What they can’t do is use their contributions to pay for a babysitter for their date night on Saturday.

Some other examples of what you CAN’T pay for:

  • You can’t pay your 13-year old to watch your two younger kids after school and then reimburse for those costs out of your DCFSA.
  • If you and the other parent are divorced, and the other parent is the primary caretaker of the children, you can’t contribute and reimburse for childcare from a DCFSA.

Who Should Consider a DCFSA?

Anyone who is a full-time caretaker of adult or child dependents and also works should consider contributing to a DCFSA if their employer offers one. You can work full or part-time, or you could be looking for work and need care so that you can look for jobs, write cover letters, and go to job interviews.

The balancing act of caring for family and pursuing a career is difficult but getting financial help with the costs can make things a little easier. If you have any questions about DCFSAs in general, check out our article: What is a Dependent Care FSA or ask your HR Department about your company’s specific FSA offerings.

Disclaimer: the content presented in this article are for informational purposes only, and is not, and must not be considered tax, investment, legal, accounting or financial planning advice, nor a recommendation as to a specific course of action. Investors should consult all available information, including fund prospectuses, and consult with appropriate tax, investment, accounting, legal, and accounting professionals, as appropriate, before making any investment or utilizing any financial planning strategy.

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