It's common wisdom that having a baby will change your life; most expecting parents read up on parenting books and prepare for sleep deprivation and the care and feeing of a newborn.
But don't overlook the financial ramifications of starting a family. Having children has a huge impact on your financial life, affecting everything from your budget and insurance needs to retirement, and should be planned for accordingly. As you welcome a child into the world, it's the perfect time to take stock of your finances and make some adjustments to your game plan.
This guide is aimed at giving you the tools to do that, broken down into distinct financial topics that should be reviewed.
According to Babycenter.com, if you are a typical American family - 35 years old, married, with a family income of $50,000 - your total cost of raising a child and putting him through a public college is around $250,000. Financial planner and father Josh Wood puts it simply: "Babies cost a lot of money; you will spend as much as $20,000 by your little one's first birthday."
Just starting out, the assault of all the "must-have" baby items can be overwhelming; but the truth is, babies don't need most of the expensive accoutrements that are marketed to new parents. Woods says that designer baby clothes are a waste of money, and urges parents to sign up for offers at diaper and formula manufacturer's websites, to receive free offers and coupons.
Money advisor Andrea Woroch of Kinoli says that with a few easy tips, parents can save on many baby products. She recommends buying essentials such as diapers, wipes and formula in bulk, which saves money as well as shopping trips. Shopping online is another way to save time, and enables you to do instant price comparisons and find online deals. "You can score free shipping from sites like FreeShipping.org or various online coupon codes from CouponSherpa.com," Woroch adds. Amazon, for example, has a free program that gives new parents and caregivers free two-day shipping for an entire year.
When you are in the stores, new mobile apps make it much easier to find coupons - two good ones are Coupon Sherpa and iCircular. Don't buy too many clothes in the 3-6 month size, the most popular size purchased for shower and new baby gifts. Woroch suggests buying one size up from what your baby needs, in case of shrinking and to get more mileage out of the clothing.
Don't overlook buying secondhand - much of the clothing is never worn, and consignment or thrift shops offer huge discounts on big-ticket items such as cribs and strollers.
Paying off your high-interest consumer debt is a good financial strategy at any time, but never more so than when expanding your family and the new expenses that will bring. If you have a $3,000 balance on a credit card charging 18 percent interest, and you pay only the minimum $60 payment each month, it will take you nearly 37 years to pay it off and cost almost $8,000. Eliminating the financial stress of debt is a top pre- and post-baby strategy. Even if you have to use non-emergency savings to pay debt off, it usually makes sense to do so.
Some experts recommend that homeowners use home equity lines of credit instead of credit cards, for major and emergency expenses. Interest rates are usually lower, and the interest is tax deductible. Just be careful to avoid the trap of overextending on unnecessary expenses this way, as your home secures this debt and could be lost if you can't pay it back.
In order to avoid future debt as much as possible, Neil Ellington of CESI Debt Solutions advises putting money into a fund for unexpected expenses, rather than handling them with debt. "It's great to have a budget and plan for the expenses you are going to expect, but you can be certain that unexpected expenses will crop up along the way as your raise this precious new baby," he says. Know the condition of your credit report as well; when major purchase needs such as a house or new vehicle come up, having good credit is a huge asset, says Ellington.
A budget is your most powerful money decision-making tool. Being responsible with money also sets up a good lifelong example for your child. Teaching good financial habits to kids is key to their financial futures. "Most children learn about finances from their parents, and if parents don't save, their children might not - creating a very damaging family cycle," says Ilene Davis, CFP, MBA. She mentions a recent financial literacy paper from Dartmouth College and Harvard Business School, which showed that couples who could answer three simple investment questions had an average net worth three times higher that of those who couldn't.
Researching the new costs of a baby beforehand will help you create a realistic new budget, and lessen the impact when those expenses hit your bank account. And make sure you aren't overextended on housing costs. "Mortgage payments and property taxes are your single largest household expense and can affect your ability to handle other financial responsibilities," says certified financial planner William Hammer.
Josh Wood recommends automating your financial life as much as possible. "Once baby arrives, you will have 1,001 reasons to neglect your financial life. If you aren't already doing so, now is the time to start putting back a percentage of each paycheck into savings." This pay-yourself-first tactic is a favorite among financial planners and can have great impact in the long term, even if it's just a little bit each time. The trick is to make it automatic - set up a recurring amount that is deducted from your paycheck or transferred from checking to savings each month.
Online bill pay services are also great time savers. And for budgeting medical costs for baby, most pediatricians will be happy to give you an estimate of the average costs for well-baby visits, inoculations and so on.
Everything from health to life insurance should be adjusted when a new baby arrives. One important thing to know is that parents typically have 30 days from birth to add a new child to their health insurance plan. Review your coverage, and consider switching plans or carriers if it no longer meets your needs. Make sure you know what the new premium will be when adding family members; a recent study by the Kaiser Family Foundation found that the average monthly premium for a family plan was nearly three times the cost of that of a single policy.
If you work for a company (not self-employed), you have an excellent financial tool at your disposal - the Flexible Spending Account. This allows you to save up to $5,000 tax-free to pay for deductibles, co-payments, prescription medications and most any other medical expense that insurance doesn't pick up. Because this money is never taxed, it represents a savings of whatever tax bracket percentage you fall into. For the self-employed, a similar plan called a Health Reimbursement Arrangement is available.
Getting the right kinds of insurance is paramount. The general rule of thumb for life insurance coverage is five to seven times annual income. For families with young children, it should be closer to ten times your income, according to financial planner Alexey Bulankov. "While this figure may seem intimidating at first glance, for young healthy parents the cost of term insurance with one million dollars in coverage is usually not much more than their monthly gym dues or a utility bill." Term insurance is recommended by most financial planners for young, healthy people; it is fairly inexpensive, especially compared to permanent life insurance policies with a savings component. There are far more attractive places to save and invest your money.
Marina Goodman, Investment Strategist at Brinton Eaton and a mother of three, adds that disability insurance for all wage earners is crucial; if your family depends on you financially and you are out of work due to injury or illness, it could create a financial catastrophe.
Lastly, you will probably receive offers to purchase life insurance for your baby. Yes, it's morbid - but more than that, it's unnecessary. Life insurance is meant for someone whose death would create a financial hardship. This is insurance you should skip.
This is a very important item to revise when you have children. All new parents should craft a basic estate plan that includes wills for both parents, a health care proxy and power of attorney. It should outline who the baby's guardian will be if both parents pass away, and give directions for how assets would be distributed.
Darren Scrimpshire, a financial adviser with Sapient Financial Group, says that concerns about providing for a child should something happen to the parents are some of the most common questions he gets. While life insurance can make sure your child is adequately provided for financially, it's important to have a will and trust in place to control how and when the money is distributed.
"Having the funds from the death benefit go into a trust for minors ensures that the money will be managed by a professional money manager and that you get to set the rules on when and under what conditions the child will (or will not) receive funds," Scrimpshire says. "You're effectively in control from the grave. If you don't do this, the State could be in control and you could have an 18-year-old receiving a check for several million dollars."
Bulankov suggests that couples have a family discussion before drafting these documents, and spend some time with an attorney to create them. "This is a discussion that most people would rather not have," he admits. "This discussion can be hard, stressing and irritating, but this is one of the most important decisions parents will have to make." If you plan to have more children in the future, be sure to mention these plans to the attorney or professional drafting your will, guardianship and estate documents.
If you're overwhelmed so far by reading about (and experiencing first-hand) the huge expenses involved with having children, you can take some solace in the tax benefits that you receive. First is the extra personal exemption you can take for each child, which was $3,650 in 2010. There is also the child and dependent care tax credit, which you can qualify for if both spouses work, until the child is 13 years old (or older if she has a physical or mental disability). However, you typically cannot receive the tax benefits from both a Flexible Spending Account and the child-care tax credit. If you have to choose, the FSA usually gives you the biggest financial advantage.
You also get to claim the annual $1,000 child tax credit, available to everyone who has children under age 17 and earns no more than $110,000 per year. Tax credits are far more valuable than deductions, because a credit reduces your actual tax bill, while a deduction reduces your tax by the percentage of your tax bracket. For example, with a $1,000 tax credit you have reduced your tax but the full thousand. A $1,000 deduction, by contrast, will save you only $300 if you are in the 30 percent tax bracket.
The Earned Income tax credit is meant to assist low to moderate income working families. The credit depends on your income and number of children; for 2011, if you make less than $50,000 jointly you should look into the EITC. Contributions of up to $2,000 per year to a Coverdell Education Savings account are tax-free; saving for college is covered in more detail in the next section.
Lastly, if you adopted your child, there are many tax benefits with that as well. A maximum adoption credit of $12,150 is allowed for joint filers with income up to $222,180. Additional benefits for special-needs adoptions exist, which do not you're your actual expenses into account.
Even though your new baby is small, it's not too early to think about saving for college, or even pre-college private school if that is of interest. The Coverdell Education Savings account, mentioned above, is one of the best vehicles for putting away money for tuition because up to $2,000 annually can be invested tax-free. Adam Koos, president of Libertas Wealth Management Group, says that a Coverdell Educational IRA is the best way to save for private, pre-college education and should be looked at if you are thinking about sending your child to private school.
For college, Koos advises using a state-sponsored 529 plan to save. Most 529 plans automatically shift the account allocation from more volatile stocks to relatively stable bonds as the child nears college age. This investment option is ideal for people who want to put their college savings plan on autopilot.
"I recommend our clients put $2,000 a year, per child, into the 529 plan so as to take advantage of the maximum state tax deduction," Koos says. "We invest it in an age-based conservative option to keep the money safe, but still offer some potential for growth. Any additional savings, I recommend using a plain Jane brokerage account, which doesn't offer any tax deferred savings, but offers the maximum safety and flexibility as far as investment options and dynamic portfolio management."
Grandparents can also contribute up to $13,000 each to your child's 529 plan, and can also contribute five years worth of money at one time without incurring any gift tax.
Koos cautions that the only disadvantage of a 529 is the fact that you can only make one investment re-allocation per year, which can become an issue if you want to move your money more than once a year due to market fluctuations. He also warns against over-funding a 529. "Not many parents do this, but if you do over-fund your 529 plan and use the assets for non-educational items, you could be subject to both taxes and penalties upon withdrawal."
Also keep in mind that when the time comes for your child to apply for college, certain education savings that you have made could be considered by the FAFSA (Federal Application For Student Aid) to be assets owned by the child, thus decreasing the needs-based calculation that would offer your child more loans and grants.
Saving money in a child's name under the Uniform Gift to Minors Act can also have the same effect of acting as the child's asset and therefore reducing her qualification for financial aid. In addition, money saved under UGMA is officially the child's money once she turns 18 or 21, depending on the state in which you live. Though you may intend the money to be used for education, she could withdraw it and use it for anything. However, it is a useful potential vehicle that should not be overlooked, as long as you are aware of how it works.
Lastly, a simple Roth IRA can also be used to accrue education money. Bulankov points out that a Roth contribution is made with after-tax money, and therefore can be withdrawn without taxes or penalties after a certain time. Qualified higher education expenses, which avoid penalties for withdrawal, include tuition as well as fees, books, supplies and other equipment needed for school.
"Under the current law, having funds in the retirement account will not adversely affect your chances of getting financial aid," Bulankov says. "Should junior decide to drop out of college to start a new Facebook or Google, he can still use this money for his retirement in case the idea does not work out." He can also use the Roth money to pay for a family member's education, including his future spouse, children and grandchildren.
Though saving for your own retirement is the last section in this guide, that doesn't mean it should be a last priority. In fact, many financial planners recommend putting away money for your retirement before you save for your children's college expenses. As Bulankov puts it, "You can finance education, but you cannot finance retirement." Your child will have a bigger burden later on if he has to support you in your older age.
Goodman agrees, suggesting that you save for college only after your household budget and retirement plans are in order. "Don't make the children's education a higher priority than your own retirement. They can use loans to pay for education; you can't do the same for your retirement. Once you're financially secure and are saving adequately for your own retirement, you can start saving for your children's education. That way, when college comes, you won't have to adjust your lifestyle as much to pay the bills."
She says that even for people in their forties or fifties, it's not too late to save for retirement, although the closer you are to retiring the more money you should be putting away. If your employer offers a 401(k) program you should take advantage of it, contributing as much as possible right out of your paycheck. Many employers have some sort of a matching program, which will help your savings grown even more.
Traditional and Roth IRAs are also both good vehicles for investing in your retirement. With a traditional IRA, you can deduct up to $50,00 per year of contribution into the IRA (for people under 50 years old), giving you the tax savings today. With a Roth IRA, on the other hand, you pay taxes on the money you are putting away but when you withdraw the money, you do so tax-free. You should consult a financial planner or CPA to determine which is best for your needs, age and income level. Many people recommend the traditional IRA because presumably, your tax bracket at retirement will be lower than your tax bracket today. However, with the Roth your money continues to grow tax-free, making it an exceptionally popular retirement savings tool.