By Michael Fink | Manager, Tax
Giving birth or adopting a child is a wonderful life-changing event. Parents have said their lives were forever changed when they added a child to their family. But do all parents make changes to their personal finances? There’s a lot to take in with a new baby – learning how to function on a few hours of sleep, understanding feeding patterns, realizing which setting on the swing is the magic spot, and maybe adapting other children in the house to a baby. But in addition to discovering a new life rhythm, parents should invest time and effort into establishing their personal financial plan to accommodate their newest addition.
Here are some key considerations for new parents:
Create and finalize a will
It’s completely understandable to not want to consider another guardian for your child. But unfortunately, life can throw curveballs, and it’s better to have your child’s interest laid out in plans to your liking, versus being determined by the probate courts. Here are a few steps:
- Nominate a guardian for your child, and make sure they are aware of your decision.
- Designate a property custodian for your assets that cannot yet be inherited by your child.
- Important question: Should the guardian and asset custodian be the same person?
Life insurance can be used to fund your child’s care in the event you pass away.
- Term (10/20/30 years) or permanent life insurance policies should be considered – consult a life insurance professional to discuss the best option for your family.
- Both parents (including a stay-at-home parent) should have life insurance policies. If a stay-at-home parent passes away, the surviving spouse would likely need to pay for childcare.
- According to the Social Security Administration, 1 in 4 of today’s 20-year-old becomes disabled for 90 days or more before they reach retirement age (67).
- Social Security Disability benefits are modest: $1,234 per month on average as of 2019.
- Short term policies can provide 3-6 months of coverage and long-term policies can cover years. These policies can cost approximately 1-3% of your yearly income.
- When exploring disability insurance, “own-occupation” policies should be considered. A policyholder can receive benefits if they are unable to work in their “own-occupation,” but they can still seek employment elsewhere.
Establish a 529 plan
College may seem far away when your changing your newborns diapers, but time will quickly pass, and establishing a college saving account can build funds over time.
- Account owners can contribute funds to a savings plan. The money in the plan is invested and grows over time. When the account owner uses the money for higher education expenses the funds (including the earnings) are not taxed.
- The State of Ohio allows a $4,000 per person (or married couple) deduction per plan beneficiary.
Select a Health Savings Account (HSA)
- Health Savings Accounts are eligible to be used with a high deductible health plan (HDHP). This allows the account holder covering a family to contribute up to $7,100 in the 2020 tax year. These contributions are deducted from taxable income and are tax free when withdrawn if used for qualified health expenses (diapers, formula, prescriptions, etc.).
Dependent Care Flexible Spending Account
- A pre-tax benefit account – funds are typically withdrawn from your paycheck for deposit into the FSA before taxes (including payroll taxes) are deducted.
- Amounts withdrawn from the account for qualified dependent care expenses are not taxed.
Continue contributing to retirement plans
- Costs of raising children can make it difficult to continue contributing to a retirement account, such as a 401(k).
- It is still important to plan for retirement and opting to receive employer matching can help ease the burden. A typical matching scheme is where employers match 50% of the first 6% of eligible wages; meaning, if you contribute 6% of your salary your employer will contribute half of that amount.
Emergency fund and budgeting
- Establishing an emergency fund may be difficult, especially for younger families, but should be a disciplined practice. Parents should save enough to cover 3-6 months of expenses.
- Devising an overall budget and tracking progress against this budget each month can help control the additional costs associated with raising a child.
- Make sure to claim your child as a dependent on your tax return, which can allow you to take the child tax credit of $2,000 ($1,400 refundable).
- You may also be able to claim the dependent care credit for childcare expenses.
Welcoming a new child into your family is truly a perfect time and should be cherished, as it goes too fast. Setting time to create a sound financial plan for your family’s future will be in the best interest of you as a parent and your child.