By Joel Chouinard, ChFC®
January 4, 2024
Becoming a parent is up there with some of the biggest moments in a person's life. From feeling tiny hands wrapped around your fingers to watching them take their first steps, the first years of a child's life can be magical. Nevertheless, it can also be stressful as parents learn to navigate increased financial responsibilities on top of the many other challenges of raising a newborn. In this article, I will break down five financial items to add to your to-do list before your due date.
1. Review Your Expenses/Budget
If you are becoming a parent for the first time, buckle up, because your expenses are about to go up. If you already have kids, you know the drill…back to diapers and baby food! All jokes aside, babies are expensive little things and parents should review their budget every time they are adding a new human to their family.
I’ve discussed this multiple times in previous blogposts (you can read a step-by-step guide to creating a budget here) but reviewing your budget should be one of the first things you do when hitting a new major life milestone, including having a baby. This will help remove unnecessary expenses from your life to make room for new ones, such as diapers, food, clothes, and the biggest one, childcare. Reviewing your budget should also play a big part in the decision of whether one parent will stay at home versus going back to work. Couples should estimate their future costs for childcare (daycare, nanny, etc.) and figure out whether they will outweigh the loss in income. This decision should not be made solely based on money, but knowing if there is a net positive versus a net negative income will help.
2. Review Your Disability and Life Insurance Coverage
One thing that makes parenting so great (and so difficult) is the fact that your children’s lives are completely dependent on you. Early on in their lives, they are dependent on you for literally everything, from feeding to cleaning them. But even as they get older and act like you don’t exist (I’m not there yet with my kids, but I’ve heard this many times), they still depend on you to put food on the table, buy them clothes, and put a roof over their heads.
If your income were to go away for a period of time (in the case of a disability) or forever (in the case of death), your family might struggle to keep up with their current standard of living. A good rule of thumb is to have at least your monthly basic needs expenses covered by your disability coverage and to have 8-10 times your annual salary as life insurance coverage. Note that these are rules of thumb, and each situation is unique, so I always recommend doing a thorough analysis of both your disability and life insurance needs.
3. Establish/Update Estate Documents
To stay in the same vein of “what if something bad happened?”, another important area to address for new parents is establishing/updating basic estate planning documents. Nobody likes to think about the unthinkable, but if you and your spouse were to die without a will, it would be up to the probate courts to decide who would be the legal guardian of your children. The judge would appoint guardianship to whoever makes the most sense and the situation that would least disrupt the children’s lives. The main issue is the judge may not understand your family dynamics and may pick someone you would have never named in your will.
To avoid this issue, parents need to establish a basic last will with a guardianship provision, dictating who would be in charge of their children if something happened to both of them. The probate courts would then simply assign the children to the legal guardian named in the will, rather than having to appoint one. If you already have a last will, it’s important to review and update it to ensure the named guardian is still who you want it to be.
Other important documents to consider would be advance medical directives, powers of attorney (durable and medical), and HIPAA release forms. Trust planning can also be considered for more complex situations, such as when privacy is needed, or when you are dealing with a child with disabilities.
4. Get Started Early on College Savings
One of the most significant gifts parents can give to their children is the gift of free education. Many studies have found that earning a college degree leads to better jobs and higher income*, so it’s no wonder why many parents want to pay for their children’s education, or at least a portion of it. But a college education can be extremely expensive, especially for students pursuing graduate degrees, such as medical school or law school. According to the Education Data Initiative, as of September 2023, the average total cost of law school in the U.S. was $220,335 (including living expenses)**. Although students can take out low-interest loans to fund their college expenses, it could take years to repay them, even with a multiple six-figure income.
As a parent of a newborn child, you don’t necessarily need to figure out right away exactly how much you need to accumulate by the time your kiddo goes to college. The reality is we have no clue what’s going to happen in 18 years. What school will they go to? Will they go to grad school? Will they earn a scholarship? What’s most important is to start saving early, even if it’s a small amount. You will start building your savings “muscle” and every year, you can increase your contributions and let compound growth do its thing.
A good vehicle to save for your children’s education is a 529 account. Your contributions grow tax deferred and the money can be taken out free of federal taxes and may be free of state taxes if used for qualified expenses. There is typically no minimum investment required to open an account and no maximum contribution (although you must be aware of gift taxes if you plan on making large contributions every year). Additionally, thanks to the SECURE Act 2.0, if the funds end up not being used for education expenses, they can be rolled over to a Roth IRA later down the road***.
5. Take Advantage of Tax Breaks
So far, I’ve mainly discussed the financial pitfalls that come with being a parent. Thankfully, certain breaks in the IRS code can actually help parents with young kids keep more money in their pockets. For example, you may have access, through your employer, to a Dependent Care Flexible Spending Account (DCFSA). A DCFSA allows you to contribute, on a pre-tax basis, up to $5,000 per year to a special account that you can use to pay for childcare. If your employer does not offer it, you can instead take advantage of the Child and Dependent Care Tax credit on your tax return. Note that you can only benefit from the DCFSA or the Child and Dependent Care Tax Credit if you incur childcare expenses because both you and your spouse work (e.g., you can’t use the DCFSA funds to pay for a babysitter while you and your spouse go out on a date).
As a new parent, you could also be eligible for the Child Tax Credit, which is $2,000 per qualifying dependent under the age of 17. However, the credit decreases if your Modified Adjustable Gross Income exceeds $400,000 for married filers and $200,000 for all other filers. If you make above those income limits, the credit is reduced by $50 for each $1,000 of income that exceeds the threshold****.
Final Note
As you may have noticed by now, there is a lot of planning that comes with having a baby. And I’ve only discussed financial planning. I haven’t mentioned anything about prepping the nursery, prenatal classes, or selecting a daycare. Partnering up with a financial advisor can remove a lot of that burden and ensure everything is in place before your baby arrives.
Sources
* https://www.forbes.com/advisor/student-loans/is-college-worth-it/
** https://educationdata.org/average-cost-of-law-school
*** https://www.bankrate.com/retirement/roll-over-529-roth-ira/
**** https://www.irs.gov/credits-deductions/individuals/child-tax-credit
SharpEdge Financial LLC is a registered investment adviser registered with the State of Texas. Registration does not imply a certain level of skill or training. The views and opinions expressed are as of the date of publication and are subject to change. The content of this publication is for informational or educational purposes only. This content is not intended as individualized investment advice, or as tax, accounting, or legal advice. Although we gather information from sources that we deem to be reliable, we cannot guarantee the accuracy, timeliness, or completeness of any information prepared by any unaffiliated third-party. When specific investments or types of investments are mentioned, such mention is not intended to be a recommendation or endorsement to buy or sell the specific investment. The author of this publication may hold positions in investments or types of investments mentioned. This information should not be relied upon as the sole factor in an investment-making decision. Readers are encouraged to consult with professional financial, accounting, tax, or legal advisers to address their specific needs and circumstances.