Bummer Summer? How to Salvage Dependent Care Accounts

With many summer activities on indefinite hold due to COVID-19 lockdowns, parents may find themselves at a loss with how to use funds they have set aside in dependent care flexible spending accounts. Retirement Director Ben Rizzuto offers strategies for how to potentially salvage contributions made to these “use it or lose it” accounts so they can still be put to use for children’s benefit.

Summer is the season many of us look forward to all year. And for school-age kids, the standard three-month vacation and all the freedom and activity it can bring holds a special appeal. Unfortunately, due to the lockdowns enacted to contain the COVID-19 pandemic, many families’ summer plans have been put on hold, pushed back or even canceled completely.

Most American kids have been learning from home for the past couple of months, only able to interact with friends and teachers via online meetings. School activities such as sports, clubs and even just after-school visits at friends’ houses have long been canceled, and those cancellations have now bled into the summer. For my daughter, the stay-at-home order here in Colorado has led to the postponement of her bat mitzvah and the cancellation of the beloved summer camp she has enjoyed for the past several years.

It’s shaping up to be a bummer of a summer! And now, the crisis we are all facing throws yet another wrench into the works: What should we do with our dependent care accounts?

Salvaging Your “Use It or Lose It” Accounts

At the beginning of every year, my family earmarks a certain dollar amount to be funneled into a dependent care flexible spending account (DCFSA) for our child over the course of the year. We do this for planning purposes, but from a financial standpoint, remember that the main benefit of a DCFSA is that the money set aside in the account is pretax, thus reducing the amount of income subject to taxes. This amount can be up to $5,000 per year and may be used for licensed nursery schools, qualified childcare centers, adult daycare facilities, after-school programs, summer camps for dependent children under the age of 13 and preschool tuition.

Now that most, if not all, of these activities have been canceled, however, we find ourselves with nowhere to send our kids so they can make use of these funds. And the problem – which presents a real financial conundrum – is that these are “use it or lose it” accounts, meaning that if you don’t have a qualifying expense, you could lose the amount you’ve set aside.

So, how can financial professionals and families deal with this issue and make sure they don’t lose possibly thousands of dollars due to these unforeseen COVID-19 cancellations?

The good news is IRS regulations provide an exception that allows individuals to update their elections due to a change in employment status or changes in cost or coverage. For example, the regulation speaks to a change in worksite, and since many are now working from home, this would fall under the change in employment status regulation. Additionally, the cancellation or closure of a child’s activity or school program would qualify as a change in the cost of childcare.

Given these qualifying changes, families can choose to stop or decrease the amount they are putting into their DCFSAs. The key, however, is that it’s not necessary to decrease your election to $0, which would end your participation in the plan and limit your ability to submit expenses for those that occurred prior to the date you made the change. Instead, you can opt to change your election to the amount you have set aside so far. (Be sure to check with your benefits department on how best to proceed based on your specific situation.)

What to Do with Prior-Year Contributions?

The question that remains is how will families be able to use the funds they have already set aside? The hope, of course, is that things start to return to normal later in the year and the activities and programs we all depend on eventually resume so we have uses for these funds once again.

In the meantime, it is important for people to reach out to their HR and benefits departments to find out if their employer has made any updates to the company benefits plans, specifically whether the plan has a two-and-a-half-month grace period exception for DCFSAs. This grace period allows participants to use their prior-year contribution amount for expenses incurred during the two and a half months following the end of the plan year. Finally, we’ll have to wait for guidance from the IRS – or for our employers to make changes to these plans – to provide some relief.

While a DCFSA is a small part of the financial puzzle, it plays an important role for many families when it comes to kids’ activities. So even though kids may be stuck with their boring parents in the coming months (and vice versa!), there are some important steps parents can take to help ease some of the financial pain associated with this bummer summer.

UPDATE: Shortly after this writing, the IRS provided more guidance to help employers and employees rectify this issue.

IRS Notice 2020-29 provides cafeteria plans with temporary flexibility to allow employees to make certain prospective mid-year election changes for employer-sponsored health coverage, health flexible spending accounts (FSAs) and dependent care assistance programs. The notice also allows employers to extend the period for which unused amounts remaining in a health FSA or dependent care assistance program may be used to pay for or reimburse medical or dependent care expenses.

It’s important to note, however, that employers must choose to make these amendments. So at this point, it will be up to employers to make these changes to help ensure families don’t lose these funds.