If you’re planning to have children soon or you’re already expecting, congratulations! After the celebration, it can be easy to become overwhelmed with questions. Children bring drastic changes to your life—including your finances. According to the USDA, the average cost of having a child in 2021 is $14,846/year. With numbers like that, you need to put a plan in place and prepare for what’s on the way.
Some people love it, some hate it, but budgeting for a baby is crucial for navigating the major life change that expecting parents will soon experience—especially if this is your first child. It’s important to know where to start.
When planning finances for a new baby, first consider the big-picture items. Is your house or apartment a good fit for a child? Is it large enough to accommodate a growing family? Is it in a kid-friendly neighborhood? What kind of renovations do you need to make room for the baby? Do you need to upgrade your vehicle? Trust me, trying to put a car seat into a two-door hatchback gets old fast.
Another big decision is whether both parents will continue working once the baby comes, or whether Mom or Dad will stay home. If one parent stays home, will it be for a year or two, or permanently? Know your company's maternity leave benefits thoroughly. Benefits can vary widely by employer and state. Ask your HR representative if Dad will get paid time off to help get everything situated. Understanding these benefits will have a significant impact on your new post-baby budget.
Once you’ve pondered some of the big decisions, create a list of expenses you anticipate will come with the baby. First, start a list of big-ticket items you only plan to purchase once. Here are some things to consider when financially planning for a baby:
Now that you have a good sense of your initial one-time expenses, start listing of the things you’ll be buying regularly, like:
When it comes to deciding how much to budget for a new baby, keep in mind that you may spend a lot less on yourselves when the baby comes to help offset some of these new costs. Date nights and events out with friends tend to take a backseat when your focus shifts to caring for a newborn.
Planning finances for a new baby means you’ll need to direct your attention in other areas once the baby arrives. Be sure to add your child to your health insurance plan, and as a contingent beneficiary on life insurance, 401(k)s, or IRAs, and other accounts you hold with a beneficiary. If you have any legal documents in place, now is a good time to set a reminder to include your new child.
While short-term needs and responsibilities are the most important to take care of right off the bat, it’s never too early to start planning for your child’s education. The diaper changing, Paw Patrol-watching days might feel like they’ll never end, but they go by quicker than you think. Don’t put off saving for their future, because that future will be here before you know it. Having to take out student loans will hold your child back when they set out on their own...possibly even forcing them to move back home after school. The average person takes 20 years to pay off student loans.
Now let’s look at some options for saving for your child’s education.
Coverdell Education Savings Account (ESA): This custodial account’s sole purpose is paying for qualified education expenses. Anyone who falls under certain income limits can contribute to the account on behalf of your child; however, the maximum annual contribution to all Coverdell ESA accounts is $2,000 and contributions aren’t deductible. The main benefit of this type of account is Coverdell Education Savings Account withdrawal rules. Distributions for qualified education expenses are tax-free. Qualified expenses can be anywhere from K-12 to college and beyond.
Section 529 Plan: The 529 plan is a tax-advantaged savings plan designed to pay for qualified education expenses. Unlike a Coverdell ESA, there’s no annual contribution limit to a 529 plan. However, contributions are considered gifts for federal tax purposes. Therefore, individuals can contribute up to $16,000 per year (2022) before it counts against their lifetime estate gift exemption set by the IRS. There’s also an option for lump sum gifting. Up to 5 years’ worth of contributions can be made at one time, provided the contributor does not make any additional gifts to the beneficiary over the next five years. Contributions may be tax-deductible on your state income tax return.
A pre-paid tuition plan lets you buy college credits at today’s rates in anticipation that tuition will continue to increase. Your rate of return is the inflation rate of tuition, and the growth on your investment is tax-free. Not every state offers this type of plan, so check to see if it’s an option for you. Be aware that it only applies to certain in-state schools. The student must be a resident of the state where the pre-paid tuition plan was set up. These plans cover tuition only, not living expenses like room & board; they don’t cover K-12 expenses.
A 529 Education Savings Plan is what most people think of when they hear the term 529 plan, and these are the most popular college savings tools. They offer a variety of investment options for contributions. Typically, you can choose a more aggressive allocation initially, allowing for a greater return on investment while college is many years away. As they approach college-age, you can change the investment allocations to focus more on asset protection. As long as the expenses are qualified, distributions are tax-free. Qualified expenses include tuition, room & board and mandatory fees. Recent legislation allows 529 plans to be used for K-12 expenses up to $10,000/year.
You’re entitled to some positive financial benefits once you enter the realm of parenthood. Along with understanding your employer’s maternity leave policy, see if they offer a Dependent Care Flexible Spending Account (FSA). This is a great benefit if both parents will be working and daycare is required. A Dependent Care FSA is funded through pre-tax withholding from your paycheck. In 2022, the maximum annual contribution is $5,000. However, the funds in these accounts are normally use-it-or- lose-it by the end of the benefit period, so be sure to contribute only what you plan to spend on childcare in a given year. For example, if your baby is born in August and you’re able to start funding a Dependent Care FSA immediately, then $5,000 is likely too much for year one if your work also offers 12 weeks of paid maternity leave. This scenario would require the full $5,000 to be used in less than two months if your plan expires at the end of the calendar year.
Arguably the biggest financial benefit to having children is the child tax credit, which has risen significantly beginning in 2018 with the Tax Cut and Jobs Act which raised the credit from $1,000 to $2,000 per child under age 17 for parents making less than $400,000 annually (married filing jointly). In March 2021, the American Rescue Plan Act increased the credit to $3,000—and $3,600 per child under six for families making less than $150,000.
If you fall above the $150,000 phase-out, your benefit reduces by $50 for every $1,000 you make above $150,000 until the credit returns to $2,000. The $2,000 credit is then in place until your income reaches the $400,000 (MFJ) phase-out. Another feature of the American Rescue Plan is that half of the credit can be paid in advanced monthly payments from July through the end of the year. Note that the changes to the child tax credit made by the American Rescue Plan Act are only for the 2021 tax year. The Build Back Better Bill passed by the House in November extends the expanded benefits, but has not been passed by the Senate at the time of this article. If no agreement is reached in the Senate, the Child Tax Credit for 2022 will revert to $2,000.
Whether you’re excited, anxious, or straight-up terrified about becoming a parent, a financial advisor can help guide you through the many financial decisions you’ll face in the years ahead—from budgeting for a new baby to planning for your child’s future.
Allegheny Financial Group is a Registered Investment Advisor. Securities offered through Allegheny Investments, LTD, a registered broker/dealer. Member FINRA/SIPC.
Author: Brian Cartier, CFP®, Financial Planning Analyst | Allegheny Financial Group | January 2022