Four Tax Breaks That Can Ease the Cost Having a Baby

No matter how excited you are about having a baby, it’s completely normal to also feel overwhelmed by the financial responsibility.

Childcare alone can cost thousands of dollars per month in some areas, and medical costs can be high as well, especially during pregnancy and in the first year after birth.

It’s a real challenge, but you can ease the burden if you know how to take advantage of a few special accounts that offer big tax breaks for some of your biggest expenses.

Here’s what you need to know.

Tax Breaks for Childcare

Childcare is often the biggest expense new parents have to deal with, but there are a couple of ways to defray the cost.

Many employers offer something called a Dependent Care Flexible Spending Account, or Dependent Care FSA for short. The IRS allows you to deduct contributions to these accounts and then withdraw that money tax-free for eligible dependent care expenses, such as childcare, a nanny, and other services.

This essentially serves as a discount on childcare at the rate of your tax bracket. So if, for example, your tax rate is 30% when you factor in federal, state, and payroll taxes, you are effectively paying 30% less for childcare when using money from your Dependent Care FSA.

You can enroll and set up contributions during your employer’s Open Enrollment period, which is often in the fall. The maximum annual contribution is $5,000, though your employer can set a lower limit if they’d like. The big drawback is that any money still in the account at the end of year is lost, so you should only contribute as much as you’re sure to use.

If you don’t have a Dependent Care FSA, or if your childcare expenses are higher than the maximum contribution, you could also take advantage of the Child and Dependent Care Credit.

This credit can reduce your tax bill up to $2,100 per year depending on your income, the number of children you have, and the amount of childcare expenses you have. The catch is that you can’t claim the credit for expenses that were paid from your Dependent Care FSA, so in some cases you might need to make a choice between the two.

It’s a good idea to speak with a CPA if you’re unsure which path is right for you, but in general families in higher tax brackets stand to benefit more from contributing to a Dependent Care FSA, while families in lower tax brackets stand to gain more from the Child and Dependent Care Credit.

Tax Breaks for Medical Care

When it comes to medical expenses, there are two main types of accounts that can provide some significant tax breaks.

A health savings account (HSA) is typically the best option, if you’re eligible. Contributions are tax-deductible, you can withdraw the money tax-free for medical expenses, and there is no “use-it-or-lose-it” rule. Any unused money simply stays in your account and can be used in subsequent years. Families can contribute up to $6,900 per year, and HSAs can even be used as effective retirement accounts.

The downside is that most people aren’t eligible to contribute to an HSA. You can use this tool to see if you might be eligible, though it’s worth contacting your health insurance company to verify.

If you aren’t eligible for a health savings account, you may be able to take advantage of your employer’s Healthcare Flexible Spending Account. These work just like the Dependent Care FSA, except that the money can only be used tax-free for medical expenses.

The IRS limits Healthcare FSA contributions to $2,650 per year, per employer, and they are use-it-or-lose-it just like the Dependent Care FSA, though your employer can allow you to carry over up to $500 into the next year.

For the most part (with some exceptions), you can’t contribute to both an HSA and a Healthcare FSA in the same year, so you’ll have to make a choice if both are available to you. With the higher contribution limits and the ability to carry over unused money, the HSA is usually the better option if you’re eligible.

The More You Know

None of these tax breaks eliminate the challenge of budgeting in all your new baby expenses, but they can make it easier.

The key is knowing which accounts you’re eligible for, estimating ahead of time what your eligible expenses will be, and signing up for these benefits before the opportunity passes. With the right planning and preparation, you can save a lot of money.

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Matt

Matt Becker, CFP® is a fee-only financial planner and the founder of Mom and Dad Money, where he specializes in helping new parents take control of their money so they can take care of their families. He spends most of his free time building Legos and jumping on the couch with his two young boys.