Are you expecting a new addition to your family? If so, congratulations! If you’re reading this and simply thinking about having your first child, I give you extra congratulations for being ahead of the game. With a two-and-a-half-year-old daughter and another due in six weeks, I can assure you this advice comes from a mixture of professional background and personal experience.
In last week’s blog post, my colleague Jordan Lochner Mills shared some ways parents can prepare for the $245,340 price tag that can come with raising a child, a figure that was developed by the USDA.1 While it would be reasonable to ask why this metric is studied by the same agency that projects the cost to raise livestock and soybeans, let’s instead focus on how you can prepare for the future impact of that eye-popping expense, while managing the transition into fatherhood.
Here are some actionable tips and higher-level thoughts to keep in mind throughout your time as “Dad”.
Use Your Tax Return to Your Advantage
Buried in the complex tax code are some nice provisions that can help parents lighten their tax burden. For each qualifying child under age 18, parents are generally eligible for up to a $1,000 federal tax credit, subject to income limitations. That means if you received the full credit every year until your child turned 18, you would receive $18,000 in tax credits — almost eight percent of the USDA’s estimated cost!
Additionally, parents with dependent children may be entitled to a dependency exemption, which is set to be a $4,000 deduction in 2015, subject to income phase-outs. For a taxpayer in the 25 percent federal tax bracket, that can be worth another $1,000 in additional refunds — and that doesn’t even consider any state benefits.
Child Care – The dreaded day-care bill can also lead to some slight relief on your tax return. The Child and Dependent Care Credit generally allows parents to claim a tax credit determined by an income-based percentage of the first $3,000 of out-of-pocket child-care expenses paid to a qualified provider for one child (based on $6,000 in total expenses for a family).2 Previously, the credit was maxed out at 10 percent (equivalent to a $300 credit), but President Obama has included proposals to increase those limits.3
Notice that I mentioned “out-of-pocket expenses”. If you have a dependent care flexible spending account (FSA) at work, you may benefit more from using those funds to pay for qualified expenses as opposed to the credit, and should consider using those first.
You can contribute pre-tax dollars (up to $5,000 in 2015) to this account to pay for your dependent care expenses.
If you already received a tax benefit on the FSA dollars, you aren’t allowed to also receive the tax credit based on those same dollars. However, as many of us know (and others may soon find out), it isn’t hard to incur enough dependent care expenses to fully utilize both the FSA and the tax credit. Medical FSAs or health savings accounts (HSAs) can also help you garner tax savings and may be available through your employer, depending on your health insurance plan.
College Education – If you are able and willing to start setting aside money for your child’s college education, there are some tax-advantaged methods you can use. My colleagues have covered this topic in previous blog posts, explaining best practices for using 529 accounts and financial aid; you can read more about these options here and here.
Saving for a child’s education is an admirable goal, and one that doesn’t need to be attempted alone (think birthday gift ideas for family). However, it should only come after your more immediate needs have been met; those needs would include saving for your own retirement. After all, you can help finance your child’s education through loans, if need be; you can’t borrow for retirement. Of course, this choice is dependent on your unique financial situation, so it’s important to discuss the balance with your tax and financial advisors to arrive at the most optimal outcome for you.
Consider the Big Picture: Insurance and Estate Planning
If you haven’t considered increasing your insurance yet, that should go on your financial to-do list, as well. Since you have another family member relying on you, it’s important to take appropriate measures to ensure they are taken care of if something should happen to you. This advice applies to scenarios where you pass away or become disabled.
There are many different “rules of thumb” for how much life insurance one should have to protect against one’s passing. Many people suggest that your life insurance coverage should be equivalent to eight to 10 times your salary. However, your salary is just one of many considerations you should keep in mind when assessing coverage. It’s also important to account for your mortgage(s) or other debt, the age of your child or children, the amount you’re willing to provide for college costs, your family’s housing situation and your spending level, among other factors. A financial planner can help determine the appropriate amount of coverage for your situation, but suffice it to say that you will likely need additional life insurance the more your family grows.
One type of insurance you may consider is term life insurance, which matches the term of the policy with the length of time the coverage is needed. If your employer offers supplemental group term life insurance, you may want to research more affordable options (particularly if you’re healthy), as those policies are typically priced at a general premium class for everyone.
When assessing coverage options, there are a few key factors you need to keep in mind: how much income is being replaced (often 60 percent to 70 percent of your prior income), whether the income is taxable or non-taxable (generally, this will be taxable income if the company pays the premium as a benefit to you) and what the “fine print” says is covered. For example, it would be important for parents in specialized, professional occupations to have coverage that paid out if they could not perform their “own occupation” instead of “any occupation”.
Estate planning is another area that is often overlooked by young parents. One of the most important reasons to have basic estate planning documents prepared is to be able to name a guardian for your child in your will if you pass away. If you don’t name a guardian, your state will need to appoint one for you. That process can be costly, time-consuming and may cause tension between family members, so doing the extra legwork to create a will in advance is crucial.
Another important task parents often forget is to periodically review their beneficiary elections. Beneficiary elections dictate the final disposition of accounts, such as life insurance policies, individual retirement accounts (IRAs) and 401(k) plans. Naming your child as a beneficiary, if that is your wish, can help ensure those dollars go directly to them and can offer the most flexibility from a taxation standpoint. Click here to read a post I previously wrote on this topic and learn more tax-friendly estate planning tips.
Modeling Financial Behavior
After working hard to employ a few of the tips listed above, you no doubt would like to see some of your improved financial acumen rub off on your child. Your child will not always listen to what you say; however, your child will tend to do what you do.
Providing for your child’s financial needs through age 18 is no small feat, but if you really want to set him or her up for a healthy financial future, it is critical to have your own financial house in order.
Model for your child what it means to be a good steward of your money. Let them see you set and follow a budget. Show them the importance of saving for retirement by doing so yourself. Help teach your children the importance of saving early, being smart with credit and setting goals by having money conversations with them early on at their level. While some of these suggestions will take a lot of effort — and possibly a complete shift in how you prioritize and think about money — the long-term benefits will be tremendous. It’s kind of like being a new dad. Congratulations, again!