WHEN BOTH PARENTS WORK, child care is a necessity. And often an expensive one—the price of day care now rivals that of college tuition in many states. Which means that paying for that care can present a real obstacle if you want to sock money away for tomorrow's education costs. Richard J. Polimeni, director of Bank of America Merrill Lynch's Education Savings Programs, offers three tips that can help you balance these competing needs.
You may be eligible for up to $6,000 a year in child- and dependent-care credits on your federal tax return.
If your employer offers a dependent-care flexible savings arrangement (FSA), take advantage of it. Currently, you can legally contribute as much as $5,000 per year ($2,500 for married couples filing separately) to an FSA. Your contribution will not count as taxable income. The money in the FSA can be used for eligible expenses, which may include day care, nannies or babysitters. Because that money is not considered taxable income, a family could reduce its tax bill by thousands of dollars depending on its tax bracket, Polimeni says. "And contributions come out of your paycheck automatically, so you probably won't miss the money after the first couple of paychecks."
You may be eligible for the child- and dependent-care credit on your federal income tax return to offset qualified child- and dependent-care expenses. You can generally claim a maximum of $3,000 in expenses paid in a year for the care of one qualified individual (up to $6,000 for two or more), so that you can work or look for work. However, the amount you claim must be reduced by the amount your employer provides for any dependent care you deduct or exclude from your income. In other words, if your employer offers an FSA, you may be fully or partially ineligible for this tax credit. The amount of the credit depends upon your qualifying expenses. Many families will qualify for a credit equal to 20% of those qualifying expenses, or a maximum of $1,200. However, families with lower amounts of adjusted gross income may receive a credit equal to as much as 35% of their qualifying expenses. Because this is a tax credit, not a deduction, it reduces the amount of tax you owe by the amount of the credit.
Saving for your kids' future education expenses can feel like a stretch when you're already paying for day care. Polimeni suggests calculating what you save on taxes by using the day-care FSA or the childcare tax credit and putting that amount into a 529 college savings plan. In addition, remember that you're not required to save the full estimated amount of your children's future expenses—anything you manage to put away will have a chance to grow, and to help when the time comes to send them off to college.
3 Questions to Ask Your Advisor
- What are some options that might help us cover the costs of day care?
- Given our situation, what types of college savings plans should we consider?
- How can we figure out how much we can put into a college savings plan?