My wife went back to work earlier this month when her maternity leave ended and our daughter went into daycare. As I’m sure happens with a lot of people, we had some nagging doubts whether going back to work was the right choice for our family, both emotionally and financially.
I think a big part of the dilemma is how we choose to think about childcare costs relative to earnings of who would otherwise be a stay-at-home caregiver. The typical thinking is something like this:
After paying for childcare out of net pay, I’m earning so little that it just doesn’t make sense to work. If I’m working just to pay someone else to raise my child, I might as well do it myself.
While I can sympathize with that logic, I think you can flip it a bit to turn into a “glass half full” situation:
What I spend on childcare is an investment, and I get returns on that investment in the form of earnings and other benefits. That return on investment, compared to other investments, may be substantial.
When you think about it that way, it helps put the financial considerations in a different light. How to care for your young child/children is an intensely personal decision, and there is no right or wrong answer. I’m simply hypothesizing that the financial considerations are a out-sized factor in the decision making process, but might not be if thought about differently.
Childcare is Expensive
According to the National Association of Child Care Resource & Referral Agencies, the average annual cost of daycare in the U.S. is $11,666, which works out to $972 per month or $224 per week. That’s just the average, and the cost varies wildly based on where you live and the type of program you utilize. When we were looking at childcare before moving out of the big city, it was going to cost us more than $500 a week to have someone take care of our son so we could work. We have friends back in the city who like to joke that they will spend more getting their son to kindergarten than to put him through college. It’s scary, but probably true.
While our childcare costs are undoubtedly lower than what they would have been if we didn’t move, it’s still the single largest item in our budget. We pay $225 per week for our toddler and $243 per week for our infant. Over the course of a full year, we’ll pay $24,336, a sizeable investment by any objective measure.
Childcare is an Investment
If paying for childcare is an investment, what are the potential (financial) returns on that investment? I think there are three that are measurable and directly related.
Incremental Net Pay. This is the amount of your take home pay in excess of what you spend on childcare. Up to that point, what you earn is simply repaying the original investment. I can already see the comments that this logic isn’t valid because you still have to work to earn the income. That’s true, but with kids in the equation the decision tree only has two branches:
- Work and pay for childcare
- Don’t work and don’t pay for childcare
There is no third path because you can’t work and not have some care provided for your children. Yes, technically, you could have unpaid childcare from a friend or family member, but that’s just shifting the foregone earnings cost from you to them.
Tax Benefits from Dependent Care FSA. The government lets you set aside up to $5,000 annually in a flexible spending account to be used for dependent care. While this covers less than half of the average annual cost, you get to exclude this from your taxable earnings. Your tax savings is dependent on your marginal tax rate:
It’s worth noting that this benefit was retained in the new tax bill and is available to people of all income levels.
Employer Match on 401k. If your employer matches 401k contributions, this is free money that you wouldn’t be earning if not working. It’s specific to each person’s situation, but has value both today as well as tomorrow due to compounding of investment returns.
Calculating the Return on Investment
Let’s do a simple example to show the return on investment for childcare. Let’s assume that this particular person is married and makes $60,000 per year. They have two kids in daycare and are paying the average annual cost in the U.S. for each. They will make the full $5,000 contribution to an FSA for childcare and contribute 10% to their 401k (on which they receive a 3% match).
First, for comparison purposes, let’s look at their numbers under the typical way of thinking. I used a net pay calculator online to figure out how much tax would be withheld, added back the FSA contribution and 401k match, then subtracted out the childcare costs.
After all of the adjustments, our person’s net pay was only $10.46 per hour, or about 36% of their gross pay per hour. For someone who was used to making a lot more prior to having to pay for childcare, it’s easy to see how these numbers would be demoralizing.
Now let’s look at the exact same numbers, but rearranged to make it look like an investment. Here you are “investing” the money spent on childcare and earning a return on it.
In this example, the person is able to earn $14,965 more in take home pay than their costs ($38,297 – $23,332 = $14,965). The greater the difference between their net pay and the cost of childcare, the greater their “return” will be as well.
They will also get back the entire $5,000 in FSA contributions that were not included in net pay and $600 in tax savings from using it (our person is in the 12% tax bracket based on their earnings). Finally, they will earn their full 401k match that they otherwise wouldn’t have if not working.
If you add it all up, this person would generate returns of $22,365 annually, or nearly double their investment in childcare each year. I’ll take a +95% return every single time. That’s an amazing result, especially considering the exact same numbers framed differently lead to a drastically different interpretation.
Other, Maybe Less Obvious Benefits
In addition to the specific items above, there are other potentially less obvious benefits that may impact your decision as well.
Reduced Lifetime Earnings Power. If you choose to take time off of work, not only do you give up current earnings but you give up potential raises on all future years too. The Center for American Progress has a tool on their website that illustrates this concept in pretty stark terms. For a 26-year old female earnings $44,000 per year, the cumulative cost of taking off 5 years is more than $700,000!
Social Security Credits and Earnings. In order to ultimately collect Social Security you need two things: credits and earnings. You need 40 credits for full benefits and earn one credit for every $1,320 in earnings, up to a maximum of four per year (2018 dollars). This means you need to work at least 10 years to qualify, but possibly longer if you had some low earning years.
The other challenge besides becoming benefits eligible is making sure your benefits aren’t unnecessarily lower. Social Security calculates benefits by averaging your 35 highest years’ income; if you have less than 35 years of earnings, then the formula uses zero for the empty years and reduces the average. Basically, you can take up to 5 years off (for any reason) and still get your maximum benefit assuming you start work at 22 and start claiming at 62.
Mental Health and Adult Interaction. I enjoy being with my kids, don’t get me wrong, but I think I would struggle to do it consistently day in, day out. My wife and a lot of other caregivers are basically Superman/woman for what they do. At least for me, I saw benefits to my own mental health from having healthy dose of adult interaction as well. I suspect others would feel the same.
Education/Development for Kids. When they’re really young it doesn’t matter as much, but I feel good knowing that my son is spending his day with people whose background is in early childhood development and education. Most of his teachers have degrees in the field or are working towards them. Seeing his growth in language, comprehension and emotional maturity, not to mention potty training progress, has been in no small part to what he does at daycare. We call his daycare “school” because he spends his day learning.
Support for Local Businesses. I have no basis for extrapolation beyond our current situation, but our children are in a daycare that is locally owned and operated. They employ around 20 people in the community, which helps support the local tax base. When so much of our consumer economy seems to be driven by large, multinational corporations, it’s nice to see at least this part of our annual spending stay local.
As I said above, how to care for your children and whether to return to work is a very personal decision. Every family must decide what works best for them because there is no right or wrong answer. I hope that thinking about the financial implications differently helps you when considering your own situation.
How does your family think about paying for childcare costs? How big of an impact does it have on your financial picture?
John started Present Value Finance in 2017 to share his experiences and insights on personal finance to help people make better decisions and take control of their financial lives.
He achieved financial independence in 2016 by walking away from the high stress world of corporate finance to focus on his family. He’s a husband, father, family CFO, and all around finance geek.
He uses Personal Capital to track his spending, investments and investments for free and recommends you do too.