Planning for the Rising Cost of Care

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Kevin Oleszewski, Senior Wealth Planner

For many parents, childcare can be their biggest monthly expense, and rising inflation hasn’t helped matters. Add in the cost of caring for aging parents? You’re likely spending a fortune on care.

that the cost of childcare has risen 41% for center-based options during the pandemic with families spending approximately 20% of their salaries on the expense. Prior to the pandemic, parents were paying an average of $9,977 for center-based childcare providers, but are now paying $14,144 annually.

And if you’re one of the 12% of U.S. adults   who are part of the “sandwich generation” – caring for both children and aging parents – you might also be contending with the high costs of adult day care or other care options. AARP reports that annually it costs family caregivers an average of $7,242 to care for aging family members.

If you are somebody who is facing care expenses on both sides, you might need some help navigating those costs. There are a few ways to manage those costs, including dependent care flex spending accounts and the Child and Dependent Care Tax Credit. We’ll dive into both of those in this article and give you some valuable takeaways to discuss with your financial professional.

Dependent Care FSAs

Offered through many employers, dependent care FSAs allow you to make pre-tax contributions to pay for qualified childcare expenses, which include daycare, preschool and summer day camps. If you choose this route, your contribution amount isn’t subject to federal or state income taxes, nor is it subject to withholdings for Social Security and Medicare.

You have to choose whether you’ll have a dependent care FSA during open enrollment or within 30 days of a dependent care event, such as the birth of a baby or adopting a child.

One thing to note with these is that you must use the funds by the end of the year, or you’ll lose them. With the astronomical costs of childcare right now, that shouldn’t be a problem. However, you should check with your employer to see if they allow any rollover from the previous year.

While the American Rescue Plan Act, passed in March 2021, raised the contribution limits to dependent care FSAs for the 2021 plan year, the limits are back to $5,000 for individuals or married couples filing jointly and $2,500 for those married filing separately.

One way to plan for how much you’ll elect to contribute is to look at what you paid on care costs last year and ensure you contribute enough to cover that.

If you find that you didn’t elect enough, you might have the option to change the amount mid-year. You might also able to carry over more from last year’s dependent care FSA and you may have a longer grace period to use those funds from 2021. Check with your employer on both of those points.

Reactive Planning with the Child and Dependent Care Credit

The Child Tax Credit advanced payments went to nearly 61 million families in 2021. ​​But it is not to be confused with the Child and Dependent Care Credit.

The Child and Dependent Care Credit provides a tax credit for taxpayers to help pay for the cost of care for children and dependents that is calculated based on your income and a percentage of care costs that you pay so that you can work or go to school.

The American Rescue Plan increased the Child and Dependent Care Credit expense cap to $4,000 for one child or dependent, and $8,000 for two or more children or dependents.

The American Rescue Plan Act upped income threshold and the maximum percentage of eligible child care expenses for the 2021 tax filing year. The maximum percentage of eligible child care expenses has increased to 50%, up from 35%, even for taxpayers with an adjusted gross income of up to $125,000. According to the IRS, for 2021 only, you can use expenses up to $8,000 for one qualifying individual and $16,000 for two or more qualifying individuals to calculate the credit.

The new thresholds and the percentage of qualifying expenses:

  • If AGI is less than $125,000, you get 50% of the qualifying expense up to a cap ($8,000 for one qualifying individual and $16,000 for two qualifying individuals).
  • If AGI is between $125,000 and $185,000, you get between 20% and 50% of the qualifying expense.
  • If AGI is between $185,000 and $200,000, you get 20% of the qualifying expense.
  • Taxpayers with an AGI over $438,000 aren’t eligible for this credit.

Another change brought on by the American Rescue Plan is that these tax credits are now refundable, whereas they didn’t used to be. This means that if your tax credit is more than your tax bill, you’ll get the difference in your tax refund.

The IRS also notes that if you’ve received dependent care benefits that are deducted from your income, you have to subtract that amount from the dollar limit that you use to calculate this credit.

For example: Randall is married and both he and his wife are employed. Each has earned income in excess of $16,000. They have two children, Anne and Andy, ages 2 and 4, who attend a daycare facility licensed and regulated by the state. Randall’s work-related expenses are $16,000 for the year.

Randall’s employer has a dependent care assistance program as part of its cafeteria plan, which allows employees to make pre-tax contributions to a dependent care flexible spending arrangement. Randall has elected to take the maximum $10,500 exclusion from his salary to cover dependent care expenses through this program.

Although the dollar limit for his work-related expenses is $16,000 (two or more qualifying persons), Randall figures his credit on only $5,500 of the $16,000 work-related expense paid. This is because the $10,500 dependent care FSA benefit he selected reduced his dollar limit.

The IRS notes that you qualify for the child and dependent care credit if:

  • Your dependent was a child under age 13
  • Your spouse was physically or mentally unable to care for themselves and lived with you for more than half of the year
  • An individual who was physically or mentally unable to care for themselves and lived with you for more than half the year and was either your dependent or could have been your dependent, but received a gross income of $4,300 or more or filed a joint return

One thing to note is if you’re married filing separately, you don’t qualify for the Child and Dependent Care Credit. And if you received your Child Tax Credit, it doesn’t affect your eligibility to claim the Child and Dependent Care Credit. The Child and Dependent Care Credit also doesn’t impact your ability to claim the Earned Income Tax Credit. It’s possible you can claim all three credits and get an even bigger refund.

Connect with Your Professional

You cannot use the dependent care FSA and the Child and Dependent Care Credit at the same time. You have to pick a lane. And the lane you pick is dependent on your unique situation and circumstances. Call your financial professional today to see which one might be more beneficial to you.

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