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 generally contribute as much as $5,000 per year ($2,500 for married couples filing separately, subject to certain exceptions) to an FSA. The amount of 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 used while you or your spouse is working. Because that money is not considered taxable income, a family could potentially reduce its tax bill by hundreds, if not 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 a credit on your federal income tax return to offset qualified child and dependent care costs incurred while you work or look for work. You can generally take into account a maximum of $3,000 of employment-related expenses paid in a year for the care of one qualifying individual (up to $6,000 for two or more). However, that amount must be reduced by any amount deducted or excluded from your taxable income by your employer as a dependent care benefit. In other words, if your employer offers an FSA, you may be fully or partially ineligible for this tax credit. The amount of the tax credit available to you depends upon your qualifying employment-related expenses and income. Many families will qualify for a tax credit equal to 20% of those qualifying work-related expenses, or a maximum of $1,200. However, families with lower amounts of adjusted gross income may receive a tax credit equal to as much as 35% of their qualifying employment-related expenses, or a maximum of $2,100. Because this is a tax credit, not a deduction, it can reduce the amount of federal income 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 dependent-care FSA or the child and dependent care tax credit, and putting that amount into a 529 college savings plan. In addition, remember that anything you manage to put away, even if it is only a fraction of the estimated amount of your children’s future college expenses, will have a chance to grow tax-free, and will 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 vehicles should we consider?
- How can we figure out how much we need to save and invest to meet our college savings goals?
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