The Dependent Care FSA Just Got a Major Upgrade: What Employers Need to Do Now

For the first time in nearly 40 years, the dependent care flexible spending account limit has changed. As of January 1, 2026, employees can contribute up to $7,500 per household annually to a dependent care FSA, up from $5,000, where it had been stuck since 1986.

That's not a typo. The limit sat unchanged for four decades while childcare costs increased more than 200%. The increase, part of the One Big Beautiful Bill Act signed into law in July 2025, is one of the most meaningful benefits changes for working families in a generation.

But here's what many HR teams and business owners don't know yet: this increase isn't automatic. Employers must actively decide whether to adopt the higher limit, and those who want to offer $7,500 must take specific steps to update their plan documents and communicate the change to employees. If you haven't acted yet, you still have time, but not much.

What Changed and Why It Matters

The dependent care FSA allows employees to set aside pre-tax dollars to pay for eligible childcare and elder care expenses: daycare, after-school programs, summer camps, and in-home care for a dependent who can't care for themselves. The pre-tax treatment reduces federal income tax and, critically, both the employee and employer save on FICA (Social Security and Medicare) taxes.

At the old $5,000 limit, a family in the 22% tax bracket saving the FICA portion would see roughly $750 to $900 in combined annual savings. At $7,500, that savings increases meaningfully, and for employers, each dollar employees run through a dependent care FSA reduces the employer's FICA liability as well.

The practical benefit for working families is real. Childcare now costs between $10,000 and $20,000 annually in most U.S. markets. The old $5,000 FSA limit barely covered a few months of care for many families. At $7,500, the benefit starts to actually move the needle on what employees pay out of pocket.

Adoption Is Optional, But the Decision Has Consequences

Here's what makes this change genuinely complex for employers: you are not required to increase your plan limit to $7,500. The federal law sets the maximum allowable limit, but your actual plan limit is controlled by your Section 125 cafeteria plan document. If you want to keep your plan at $5,000, you can. Your employees just won't be able to take advantage of the increased limit until you change it.

That said, keeping the limit at $5,000 while your competitors offer $7,500 is increasingly a competitive disadvantage. Dependent care costs are one of the most consistent pressure points for employees with children or aging parents. When employees discover that another employer offers $2,500 more in pre-tax childcare savings, that's a tangible financial difference, not an abstract benefit.

The decision isn't purely about generosity. There's a meaningful compliance risk that employers need to understand before increasing the limit.

The Nondiscrimination Testing Problem

Under Section 129 of the IRS code, dependent care FSA plans must pass what's called the 55% Average Benefits Test. This test requires that the average dependent care FSA benefit received by non-highly compensated employees (NHCEs) equals at least 55% of the average benefit received by highly compensated employees (HCEs).

Under the old $5,000 limit, many companies passed this test without much effort. But when the limit jumps to $7,500, the dynamics shift. Highly compensated employees: who are more likely to already be maxing out their FSA contributions: will simply increase their election to $7,500. Non-highly compensated employees, many of whom don't participate at all or contribute minimal amounts, may not follow suit.

If that gap becomes too wide, the plan fails the Average Benefits Test. The consequence isn't a small penalty: HCEs lose the pre-tax treatment on their excess contributions, meaning the IRS taxes them as though those dollars were ordinary income. That's a significant liability for employees, and an administrative headache for HR.

Before increasing your dependent care FSA limit, run a preliminary nondiscrimination test with your benefits administrator or Section 125 plan consultant. Understand your likely HCE vs. NHCE participation rates. If your workforce skews toward higher earners with high FSA participation, you may need an employee education campaign before open enrollment to encourage broader participation, or you may need to reconsider whether increasing the limit is actually the right move for your company right now.

What You Need to Do If You're Increasing the Limit

If you've decided to offer the $7,500 limit, here's what needs to happen:

Amend your Section 125 plan document. Your cafeteria plan document must be formally amended to reflect the new limit. The IRS requires this amendment to be in place by December 31, 2026. If you offer the increased limit in 2026 without the amendment in place, you run a plan qualification risk. Work with your TPA (third-party administrator) or benefits attorney to get this done.

Notify employees promptly. The IRS permits a retroactive mid-year election change for this specific change, which means employees can update their elections for the remainder of 2026 even outside of open enrollment. If you adopt the higher limit, communicate it quickly, many employees will want to increase their contributions immediately.

Update summary benefit materials. Your Summary Plan Description and any enrollment materials that reference the $5,000 limit need to be updated. This is a compliance requirement, not just good housekeeping.

Plan for open enrollment. If your open enrollment hasn't happened yet for plan year 2026, you have a clean window to introduce the $7,500 limit as part of the normal enrollment process. If it has already passed, coordinate with your TPA on the mechanics of a mid-year election change.

What You Need to Do If You're Keeping the $5,000 Limit

If you run the nondiscrimination analysis and conclude the increase creates too much testing risk, or if you simply want to evaluate the change before acting: communicate that decision to your employees clearly. Don't let them find out about the $7,500 limit from a news article and wonder why your plan still shows $5,000. A short explanation ("we reviewed this change and are keeping the current limit for now while we evaluate testing implications") is far better than silence.

Revisit this decision before your next open enrollment. The increased limit isn't going away, and employee awareness of the change will only grow over time.

The Tax Savings Math Employers Often Miss

There's a calculation worth doing before you make your decision. For every dollar an employee runs through a dependent care FSA, the employer saves the employer portion of FICA taxes: currently 7.65 cents per dollar. If 20 employees each increase their dependent care FSA contribution by $2,500, the employer saves roughly $3,825 in annual FICA taxes. That's not transformational, but it's real money that partially offsets the administrative cost of making the change.

For smaller employers where every expense matters, this calculation can actually tip the economics toward adoption. Talk to your payroll provider or benefits broker about modeling the FICA savings based on your workforce demographics and anticipated participation rates.

A Benefit That Was Overdue

The $5,000 limit was set in 1986 when childcare costs were a fraction of what they are today. That the limit went unchanged for nearly 40 years while working families dealt with spiraling childcare costs is worth acknowledging: the increase to $7,500 is meaningful, even if it doesn't fully close the gap.

For employers with 25 to 500 employees who are competing for talent against larger organizations with deeper benefits budgets. This is a genuine opportunity to add a high-value benefit at relatively low administrative cost. The employees who will use it, parents of young children, people with elderly dependents at home, are often exactly the employees you most want to retain.

The decisions you need to make are real, but they're manageable. Work with your benefits broker or TPA before your next open enrollment. Run the nondiscrimination test. Update the plan document. And communicate proactively, employees who are struggling with childcare costs deserve to know what's available to them., -

Benefits Collective helps employers build competitive, cost-effective benefits strategies for companies with 25 to 500 employees. If you're navigating the 2026 benefits changes and want a second opinion on your plan design, schedule a consultation to review your current approach.