Financial Planning When Starting a Family
Planning for significant life transitions is central to financial planning. As recent first-time parents, we can say with confidence that there may be no greater transition in life than starting a family.
Like any new phase of life, this transition brings along an infinite number of decisions and items to remember. Both before the baby arrives and in the weeks, months, and years after, it can be helpful to understand and plan for some of the financial challenges that lie ahead. Coming from the perspective of both financial advisors and new parents, we've provided this checklist of some key financial considerations to keep you organized when having a baby.
1. Get Started With Cash Flow Planning
Parents should plan for increased expenses associated with their new child, ideally several months in advance so they can adjust their cash flow and lifestyle before the child is born. For many parents, the most significant new cost will be childcare. Whether planning to use a daycare facility or a nanny, gathering cost estimates from multiple sources will help you plan accordingly.
Parents may also want to see if their employer offers a Dependent-Care Flexible Spending Account (DCFSA), through which you can set aside pre-tax dollars (up to $5,000 per year for those married filing jointly or as head of household) to cover the cost of dependent care. For households that may be considering one working parent, not only should you plan for the reduced income, but also consider the potential impact to employer benefits.
Another important cost to factor into your cash flow plan is healthcare, which will be covered in more detail later. If both parents are working, it is wise to carefully review each of your employer's benefits, including healthcare plans, to see which plan is most advantageous for the delivery and ongoing care of your child.
With an overall increase in living expenses, an emergency fund is more important than ever, so if you haven't already established one now is the time to do so. We typically recommend keeping between 3-6 months' worth of cash reserves on hand in an easily accessible place – this could be in your checking account (if you can trust yourself not to spend it down), a high-yield savings account, or in a money market mutual fund. In the event of job loss or some other unforeseen event, you'll want to make sure you have enough cash available to cover the basics (food, shelter, transportation, diapers) for your growing family.
Finally, if you are already saving for retirement and will now be contributing to a 529 plan or other savings account, make sure to factor in room for both in your budget. You don't want your retirement and college savings accounts to be competing for your hard-earned dollars. Both are important.
2. Plan for Your Child's Education
Given the significant cost of a college education, it's essential to start thinking about the type of education you foresee for your child and what financial contribution you want to provide. Start saving for your child's education as soon as possible, especially if you plan to send your children to private schools. To determine how much to save, talk to your financial advisor or use an online college savings calculator, which provides college cost projections and suggests monthly savings contributions. One option to make saving easy is to set up automatic monthly transfers into the savings vehicle.
Parents can benefit from using tax-advantaged education savings vehicles such as 529 college savings plans, available in each state. One of the benefits of a 529 plan is that many provide a state tax benefit. In addition, starting in 2018, parents can withdraw up to $10,000 per year from a 529 account to pay for qualified expenses related to private school tuition from kindergarten through 12th grade. Another option that provides more flexibility in spending, but is less tax-advantaged, is a custodial account (UGMA/UTMAs).
Be sure to speak with a tax professional about the specific tax implications for your situation and state of residency.
3. Adding Your Newborn to Your Healthcare Plan
You might think that your healthcare provider would know that there is a new member of the family, especially if you have filed a claim to cover the cost of the birth! The reality is that obtaining coverage for your newborn is one of your first responsibilities as a parent. Fortunately, having a baby is considered a "qualifying life event" that allows for changes to your health coverage. These special events allow for a mini open enrollment period just for you, when you can make changes to your existing health insurance policy or enroll in a new one altogether.
There is a strict time limit and plans typically require that your child be added within 30 or 60 days of birth. Coverage should apply retroactively from birth, so that all of the charges related to the child are typically covered even if they are not added to a policy until you are back home.
You should also consider increasing your Health Savings Account (HSA) contributions. HSAs are available to participants in high-deductible health plans and can be used to pay for a variety of medical expenses. Contributions to HSAs are taken out of each paycheck and reduce the amount of taxable income that you recognize on your W-2. HSAs are different from Flexible Spending Accounts (FSAs) for medical expenses, in that there is no "use it or lose it" provision – meaning there is no time frame in which you are required to spend the money, or risk forfeiture. Contributions not used during the calendar year will roll over to the next year and usually may be invested once the account balance surpasses a certain minimum threshold.
Any investment growth within the account is tax-free, and distributions from an HSA are also tax-free if used for qualified medical expenses. The current annual contribution limit is $7,100 for family coverage in 2020. Attempting to max this out is a good goal, especially considering the increased health expenses that come with a newborn.
4. Be Aware of Potential Child and Dependent Care Tax Breaks
The Child Tax Credit (CTC) provides a $2,000 tax credit per child, subject to an income phase-out starting at $200,000 for individual filers and $400,000 for joint filers. The CTC is a dollar-for-dollar reduction of your tax liability and can be claimed even if you do not itemize your deductions.
Additionally, if you are planning on using some form of childcare, be aware of the Child & Dependent Care Credit. The Child & Dependent Care Credit allows you to reduce your tax liability by up to $2,100 if you have 2 or more dependents and have incurred more than $6,000 of qualified expenses. Typically, it makes sense to use the Child & Dependent Care Credit in tandem with a dependent care Flexible Spending Account (FSA). Using the credit and the FSA together results in tax-advantaged childcare for up to $11,000 of expenses for 2 or more children. Like an HSA, a dependent care FSA is a pre-tax account sponsored by your employer.
Unlike an HSA, however, if you don't spend the FSA dollars within the Plan year, they are gone. Contributions are automatically deducted from your paycheck, and the funds can be used for qualifying childcare expenses. The maximum contribution in 2020 is $5,000. Because these accounts are funded with pre-tax dollars, using them effectively provides a discount on eligible childcare expenses equal to your tax rate.
5. Review Your Life Insurance Needs
After your child is born, life insurance is no longer optional, but is now an essential part of your plan. Determining how much coverage, as well as what type of coverage you should get, depends on your family's situation. As a general guideline for a household with two working parents, both parents would ideally have term life insurance policies which are usually quite affordable and are typically offered in 10-, 20- and 30-year increments. Even if one parent does not work outside the home, there would be tangible costs associated with losing that parent, such as the need for childcare. Everyone's insurance needs are a bit different, but generally the younger you are, the more coverage you will need (the more years of future income that you will need to look to replace).
Parents should also consider disability insurance to replace lost income in the event of illness or other factors that may impact your ability to work. Although disability insurance is frequently less of a focus than life insurance, it is actually more likely to be used.
6. Make Sure Your Estate Plan Is in Order
Outlining clear goals for how you would want all of your affairs handled is an important first step when establishing an estate plan. As a starting point, you should make sure to incorporate the following components:
- A Will, which outlines your wishes for your assets and can recommend a legal guardian of your minor children.
- A Durable Power of Attorney (DPOA), which gives the agent you name the ability to engage in financial transactions on your behalf if you are unable to do so.
- A Health Care Proxy, which names the agent who you would like to make medical decisions on your behalf if you are unable to do so.
- A Living Will, which outlines what you would like to have happen in different medical situations and acts as a guide for your health care proxy.
These documents are the main building blocks of a comprehensive estate plan. Naming a legal guardian in your Will should be your first priority, because if your intentions as the parents aren't clearly stated, the court will name a guardian of your child in the event of your death. You may also choose a separate guardian of the property of a minor, who will manage the accounts and assets until your children reach legal age – a distinct role from the person who will actually raise your children.
Parents should also update beneficiary designations on accounts to include their new child. If parents have a will or trust already drafted, you should also update those documents to include your new family member.
Of course, there are many other financial considerations that may come into play when you have a child – like figuring out the best way to structure the purchase of a new home – so walking through your personal financial situation with a qualified advisor is a great way to figure out the best path and specific actions for your family. Taking these steps to establish a solid plan before your baby is born will save you time and reduce stress so you can focus more fully on your little one.