Dependent Care FSA

A dependent care FSA (or dependent care account) is an employer-sponsored savings account in which you set aside pre-tax income to pay for childcare, preschool, after-school care, or adult eldercare. Like a medical FSA, it has a use-it-or-lose-it rule: unused funds are forfeited at year-end.

How it works

During annual enrollment, your employer offers a dependent care FSA. You elect to contribute up to $5,000 per year (or $2,500 if married filing separately). This amount is deducted pre-tax from each paycheck throughout the year.

You pay childcare, preschool, or eldercare providers directly (or receive reimbursement for receipts). You then submit claims to your dependent care FSA account and receive reimbursement from the pre-tax funds you set aside.

Example: you have a child in full-time daycare costing $10,000/year. You contribute $5,000 to your dependent care FSA. You pay $10,000 to daycare, then submit $5,000 in receipts to the FSA. You are reimbursed $5,000 pre-tax (saving roughly $1,200 in taxes if you are in a 24% bracket). You pay the remaining $5,000 out-of-pocket with after-tax dollars.

Eligible expenses

• Daycare and preschool. Full-time and part-time childcare, including in-home and center-based.
• After-school programs. Before-school or after-school care until age 13.
• Summer camps. Day camps (not overnight), including sports and academic camps.
• Adult eldercare. Adult day care, respite care for elderly parents (if they are dependents).
• Not eligible: Private school tuition, babysitting (sometimes, depending on plan), overnight camps.

The use-it-or-lose-it rule

This is the critical limitation. If you contribute $5,000 and your actual childcare expenses are $4,000, the remaining $1,000 is forfeited at year-end.

To minimize this risk:

1. Estimate carefully. Use last year’s expenses as a baseline. Account for weeks off (holidays, summer breaks), changes in care arrangements, etc.
2. Be conservative. Under-estimate slightly; it is better to pay a bit out-of-pocket than lose funds.
3. Check for grace period. Some plans allow a 2.5-month extension or limited carryover ($660 in 2024).

Tax credit alternative

The IRS also offers a child tax credit (up to $3,000 per child) and dependent care credit (up to 35% of $3,000 in eligible expenses). This is a tax credit, not a pre-tax savings account.

You must choose between:

• Dependent care FSA. Pre-tax savings (reduces AGI), but use-it-or-lose-it and $5,000 limit.
• Tax credit. Claim on tax return (no forfeiture risk), but you pay the childcare with after-tax dollars.

The FSA is usually better if your expenses are stable and you can estimate accurately. The tax credit is better if expenses vary significantly or you are uncertain.

Notably, you cannot use both for the same dollar of childcare — you must choose one approach.

Household income and eligibility

Unlike many tax benefits, dependent care FSA has no income limit. Even high earners can contribute. However, the underlying childcare expenses must be necessary to allow both spouses to work (or pursue education/job training).

See also