You need to make some tax-related decisions about your employee benefits during open enrollment in the fall.
Before deciding to sign up for a flexible spending account, which lets you set aside pretax money for child care or health care expenses, you may need to weigh the benefits compared with other tax-advantaged options.
Here’s what you need to know to assess your choices.
Dependent Care FSA vs. Child Care Tax Credit
If you’re paying for child care for kids under age 13, there are two ways to get tax benefits for your expenses: You can either contribute pretax money to a dependent care FSA, if offered by your employer, or you can take the child and dependent care tax credit.
[READ: Kids and Taxes: 6 Tax Credits Parents Should Know About]
The definition of eligible expenses is the same for both tax breaks: You can count the cost of day care or a nanny, preschool (but not kindergarten or older), before-and after-school care and summer day camp that provides child care while you and your spouse work or look for work.
You can’t take both tax breaks for the same expenses, so it’s important to do some calculations before deciding whether to sign up for the dependent care FSA for 2025.
With the dependent care FSA, you can set aside up to $5,000 per household for 2025, which you can use tax-free for eligible child care expenses. The $5,000 household limit applies regardless of the number of children, and applies to the entire family, even if both spouses’ employers offer an account. The money is contributed from your paycheck before taxes, so it is not subject to federal income taxes or FICA taxes.
The child and dependent care tax credit counts up to $3,000 in child care expenses if you have one child, or up to $6,000 if you have two or more children. The lower your income, the larger the credit. If your adjusted gross income is $15,000 or less, the credit can be worth 35% of eligible expenses; if your income is more than $43,000, it’s worth 20% of eligible expenses. There is no maximum income cut-off to qualify. The credit can reduce your tax liability by up to $1,050 if you have one child or $2,100 if you have two or more children.
How to choose: Most people come out ahead with the dependent care FSA, but it’s a good idea to run the numbers each way before making a decision — especially if your income is low and you qualify for the 35% credit.
“Within my firm, we find it best to look at the calculation on a case-by-case basis as varying income levels can affect the results,” says Stephen Mankowski, a certified public accountant in Hatboro, Pennsylvania, and member of the American Institute of CPAs .
“While the end results might vary based on the number of children, we find it’s generally best to maximize the FSA contribution. The FSA contribution is exempt from federal, Medicare and Social Security taxes,” he says.
Other Things to Consider
Sara Taylor, senior director of spending accounts for WTW, a benefits consulting firm, points out another benefit of the dependent care FSA: It lowers your taxable income with each paycheck and you can withdraw the money tax-free from the account throughout the year.
With the child and dependent care tax credit, on the other hand, you don’t benefit from the tax break until you file your income tax return after the year is over.
“The FSA has the more immediate impact for people,” Taylor says. “It’s a really good budgeting tool — it forces me to put the money somewhere to pay the expenses. That, for me, makes it more tangible.”
The contributions come out of your paychecks in equal installments throughout the year.
For example, if you sign up to set aside $5,000 for 2025 and you are paid twice a month, you’ll contribute $208.33 pretax from each paycheck. You can then use the money for eligible child care expenses as they accrue in your account.
If your child care costs are more than the amount you’ve set aside so far, you’ll gradually be reimbursed as the money makes it into your account.
“You do need to submit a claim against the account and ask for reimbursement,” Taylor says. “Employers need you to provide documentation — who the care is for and who provided the care, the amount and the time period for which the care is provided.”
The downside to the FSA is that you lose any unspent money remaining in your account at the end of the year, so you need to estimate your eligible expenses before deciding how much to contribute.
If you have two or more children and a lot of child care expenses, you may be able to max out the dependent care FSA and still benefit from the child and dependent care tax credit, Mankowski says.
For example, if you have two children and $6,000 or more of child care expenses, you can use the FSA for the first $5,000 of child care expenses and take the tax credit for $1,000 of the expenses, which could reduce your tax liability by $200 to $350 depending on your income.
Choosing Between a Health Care FSA and Health Savings Account
You may also need to decide whether to contribute to a health care FSA or a health savings account (HSA) during open enrollment, depending on the health insurance plan you choose.
You and your spouse can each contribute up to $3,300 to a health care FSA for 2025, if offered by each of your employers. Your contributions are pretax and you can withdraw the money tax-free for eligible health care costs, including your deductible, copayments and care that isn’t covered by health insurance, such as dental and vision care.
But you typically must use the FSA money by the end of the year or you will lose it. Some employers, however, give you until March 15 of the following year to use the money or let you roll over up to $660 to the next year.
You can make pretax contributions to an HSA and withdraw money tax-free for similar expenses, but there’s a big difference between the two accounts: With the HSA, there is no time limit for using the money.
[See: What Is a Health Savings Account?]
However, you can only contribute to an HSA if you have an eligible high-deductible health insurance policy. For 2025, the policy must have a deductible of at least $1,650 for single coverage or $3,300 for family coverage.
When deciding whether or not to choose the high-deductible health plan during open enrollment, factor in the benefits of an HSA: In 2025, you can contribute up to $4,300 pre-tax to an HSA if you have single health insurance coverage, or up to $8,550 for family coverage (plus $1,000 if you’re 55 or older).
The money grows tax-deferred through the years, and you can withdraw it tax-free for eligible expenses at any time in the future. Even though you can’t make new contributions to an HSA after you enroll in Medicare, you can withdraw money tax-free from the account to pay Medicare premiums after you turn 65.
Most HSAs offer a savings account for money you plan to use soon, and mutual funds where you can invest money you plan to keep growing for the long-term.
“If you can afford to put something into your HSA, even if a small amount — $50 or $500 for the year — do it because the triple tax advantages of the HSA are just golden,” Taylor says.
“If you don’t use it, you don’t lose it. It’s your money forever. If you change employers or retire, the money is still yours. You can use the money you set aside five years ago for expenses 20 years down the road. It helps you build a nest egg for health care expenses in retirement,” she adds.
[Read: The Highest Medical Costs to Expect in Retirement.]
Your Employer Might Contribute to Your HSA
Most employers contribute to HSA accounts for people who have an active high-deductible health insurance policy. The policy may cover some preventive care without being subject to the deductible and still qualify as HSA-eligible, says Bill Stuart, an independent consultant who works with administrators and employers on the design of HSA offerings.
But be sure to verify that the policy is HSA-qualified — some high-deductible policies don’t meet other requirements, he says.
If you contribute to an HSA, you can’t have a general health care FSA, too, but you might be able to have a limited-purpose FSA — if offered by your employer — which lets you contribute up to $3,300 in 2025 for vision and dental care.
It’s typically better to contribute the maximum to your HSA first, Stuart says.
“Funding the HSA is the first priority because the funds don’t expire, there’s no deadline to reimburse, you have portability from job to job, investment options and you can carry balances into retirement,” he says.
However, a limited-purpose FSA can help with budgeting for large dental or vision expenses because you can use the full amount you signed up to set aside for the year at any time, even if you haven’t contributed that much to the account yet — unlike a dependent care FSA that you can use only as it accumulates in the account.
“Say my daughter is having orthodontia and getting braces in January, I can be reimbursed from my health care FSA for the full value for the year,” Taylor says.
“It can be a really good cash flow management tool in addition to your HSA. You have to be smart about it and you have to plan your expenses. Think about a limited-purpose FSA as your dental and vision account,” Taylor adds. Calculate how much to set aside in the FSA carefully so you don’t lose any unused funds at the end of the year.
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Guidelines for Making Important Flexible Spending Account Tax Decisions for 2025 originally appeared on usnews.com
