On May 12, 2020, the Internal Revenue Service (IRS) announced it was relaxing the rules for dependent care FSAs. COVID-19’s forced closures of day cares, canceled after-school programs and spring break and summer camps, and the ensuing shift in families’ needs for dependent care made it critical for enrolled families to be able to change their dependent care contributions. Prior to this change, families would forfeit unused funds at year’s end: a shame, especially now, when every dollar counts. So the IRS responded.
Though many employers offer dependent care flexible spending accounts (FSAs) today, not all employees take advantage of them. Today only around 5 million families are enrolled in a dependent care FSA. COVID-19, remote work arrangements, and the newfound joys (!) of homeschooling due to school and day care closings have galvanized the overdue attention owed to child care and how it is financed.
This move by the IRS rewrites the challenges, opportunities, and outlook for dependent care FSAs.
Challenges
In November 2019, I published a study that profiled employers’ positions on benefits, including FSAs. At the time, 8% of employers were considering rolling back FSAs. While this number may not seem like cause for concern, it is high compared to other benefits that the survey inquired about. When we consider the current downturn in the economy, FSAs are likely to be on the chopping block. This should give third-party administrators (TPAs), benefit administrators, health plans, and technology platforms some pause.
Opportunities
Benefit administrators, record-keeping platforms, and financial wellness providers understand the value of financial benefits that can relieve employee worries. TPAs, or card networks, have remained dedicated to expanding employee adoption of FSAs. They are leveraging digital channels, frictionless reimbursement models, and consumer-friendly payment forms, such as debit cards, to continue to make it easier for users to actively engage with their FSAs.
Now with this added flexibility, they have reason to be hopeful. If they can relay these changes to their employer groups, they can generate additional account enrollments—a plus—though they may have to balance that with a decline in contribution levels.
Outlook
Prior to the IRS announcement, I was concerned that the outlook for FSAs would fizzle out unless changes were made. My wish came true, at least partly.
- Replacing rigidity with flexibility: Dependent care FSA contributions are normally set during open enrollment and are not changeable throughout the year. Now, as long as employers make amendments to their benefit plans, employees have the flexibility to change contributions, like they can with health savings accounts (HSAs), a happy step toward flexibility.
- Raising contribution levels to realistic levels: The US$5,000 contribution maximum remains sorely below the needed amount for day care settings. The annual cost of dependent care, day care, afterschool programs, and summer camps can run well beyond US$30,000 per family. I speak from personal experience, having placed two kids in day care since they were 10 weeks old. When converted to pre-tax dollars, that balloons to over US$40,000. And that is for one year. Families need child care in some shape or form for over well over a decade. Increasing the contribution limit—quadrupling or quintupling it—would be huge and provide a brand new lease on life for dependent care FSAs. It would boost the attention paid to these accounts and increase employee adoption to well beyond today’s 5 million families. This remains on my wish list.
- Keeping instead of forfeiting: Today, employees who part ways with their employers forfeit unused dependent care FSAs, with those funds reverting to the employer. Tax legislation opens a door for employees to keep their funds to a degree by allowing some form of rollovers. But this does not really allow employees to retain their contributions, like they do with HSAs. This would breathe new life into dependent care FSAs, and it too remains on my wish list.
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