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Financial Guide for New Parents
Parenthood is one of life’s most exciting and rewarding endeavors.
But it’s also a difficult – perhaps even overwhelming – undertaking. Caring for and raising a newborn human being into a healthy adult is a physically, mentally, emotionally, and financially daunting task. While you may be prepared for the physical, mental, and emotional responsibilities of parenthood, many new parents struggle to prepare their finances. The U.S. Department of Agriculture found that raising a child from infant to age 17 costs over $200,000 on average — and that doesn’t include their college education!
Parenthood is beautiful, but parenthood is tough enough without having to worry about the money involved. To make it a bit easier, here’s a comprehensive financial guide to help you prepare.
Before the Baby Arrives
Weathering the financial challenges involved in parenthood starts well before your baby arrives. You need to create as much budgetary breathing room as possible — you’ll be spending a lot of money. Financially preparing for your child involves three key steps: solidifying your emergency fund, clearing any debt, and monitoring your spending.
Formalize your Emergency Fund.
As you know, emergency funds keep you afloat when disaster strikes. Whether you or your spouse get in a car accident, lose a job, or receive a large medical bill, having no emergency fund will drain your bank account at best — and puts you hundreds or thousands in debt at worst.
For parents, a rule of thumb is to ensure you have at least six months of living expenses in an emergency fund. Living expenses include only the bare essentials — housing, utilities, food, gas, and similar expenses. Since you’ll be a parent soon, you need to factor your new child’s living expenses into your emergency fund, too.
Eliminate Debt (Prioritize High-Interest Debt).
As you prepare for baby, try to eliminate any remaining debt to free up money for you to spend on or save for your baby. Focus on your high-interest debt first — generally, personal loans and credit card debt should be your top priority. Once you have those cleared, tackle lower-interest debt, such as car loans. Don’t fret too much about attacking your mortgage. Each mortgage payment gains you equity in your house, whereas credit card debt interest is money down the drain.
Budgeting for Baby.
As a parent, you’ll have to monitor your spending more closely. You might have to make some sacrifices — such as going out to eat frequently — but you don’t need to cut out all “unnecessary” spending and make life miserable. Every person has their own happy medium of saving and spending, and it’s important to find yours before baby arrives.
Now is a good time to revise your budget. Take stock of your current financial situation while factoring in the new additions to your spending routine — things like diapers, food, baby accessories, and the like. The following sections cover essential line items to update in your budget:
Needless to say, feeding your child is going to represent a significant increase of your food expenses, regardless of whether or not you or your spouse plan to breastfeed. Formulas and baby food jars will affect your budget nearly as much as breastfeeding. In every case, do some price comparisons and shop around for the best prices on all of these items.
Just as important as food, clothing is another substantial expense that you will need to include in your budget.
Be careful not to spend too much here — your growing child will just outgrow your purchases more quickly than you expect. Unless you plan on having another child in the near future, this clothing won’t do you much good once it no longer fits.
Chances are you’ll want to have a nursery ready and waiting for your child’s arrival. You’ll likely incur these expenses before the baby is born, but they are no less important than the other ongoing costs you’ll face.
Most of these items include everything you need for the baby to sleep comfortably and store his or her essentials — clothing, blankets, baby wipes, and so on. You may even want to buy some paint and other accessories to decorate the room and make it a comfortable and inviting space for your baby.
You’ll need to buy some toys and other entertainment items for your baby — not just for his or her enjoyment, but for your peace of mind, too. Not only can toys and books get your baby on the right track for learning development, but these can all help provide an even more valuable service: making your baby smile.
Transportation is another important budgetary factor to consider because there are going to be a few items that you’ll absolutely need to purchase — particularly, if your child will be riding in the car. Per federal regulations, you will need an infant car seat. From there, you’ll probably want to get a good stroller that you can rely on for the next two or three years. These items can be expensive and can take a significant portion of your budget – as always, be sure to comparison shop.
Insurance and Your Baby
Part of your budget needs to include insurance for both you and your baby. The main types of insurance you’ll have to worry about are health insurance, life insurance, and disability insurance.
Much the same as food and clothing, health coverage is an absolute necessity for keeping your child healthy and ensuring that all upcoming medical expenses are fully covered. You don’t want to be paying those expenses out of pocket. However, whether you plan to add your newborn to your current plan or get a new plan altogether, your child’s health insurance policy premium will represent a new expense in your budget.
Life insurance is a key to securing the financial safety of your baby should something tragic happen to you. Ideally, both you and your spouse should have life insurance, but if you’re looking to cut costs, at least the breadwinner at least should take out a policy. Key tip: take out your policy sooner rather than later. The younger you are when you buy a policy, the cheaper it will be, as the insurer will consider you less “risky”.
One thing you don’t need to worry about is getting a life insurance policy for the baby. Salespeople will pitch you on buying a policy for your child as a shrewd investment for the future, but it’s not necessary. That money could be put to better use elsewhere — such as your retirement savings (we’ll discuss this more later).
There are different types of life insurance, so you need to compare the options to find your best fit. As you compare your options, calculate the amount of coverage sufficient to support your beneficiaries while covering any financial responsibilities, such as outstanding debt and any future monetary obligations. Check to see if your employer offers a policy; otherwise, talk to your insurance agent to figure out how much is enough to secure your family’s long-term financial outlook.
Life insurance is important should you meet an untimely demise, but carrying disability insurance can be just as, if not more, important. Good disability coverage should cover a large portion of your salary should you be unable to work – and that money can keep your family afloat.
As with life insurance, check to see if your employer offers a policy. Otherwise, gather multiple quotes and compare your options.
Preparing for the Future
Now that you’ve created a baby budget and your insurance is in place, you’ll want to start preparing for the future.
Commit to Your Retirement Savings:
Saving for your retirement is quite possibly the most important financial decision you can make for the future. Unfortunately, too many new parents let their retirement savings strategies fall by the wayside in favor of putting that money towards various expenses for the baby. Continue contributing to your retirement accounts to ensure your long-term financial security.
Save For Your Child’s College Education:
However, the moment you’re on track to your retirement goals and you have enough resources to put towards college education costs, start building your child’s tuition fund immediately. The earlier you start to save for your child’s college, the better.
Luckily, you have many savings options to explore, most of which offer very advantageous tax-free savings opportunities.
A 529 account is the most popular of these options. Your contributions grow tax-free, and your withdrawals are tax-free if you apply them to qualified educational expenses.
Coverdell accounts are another option if you fall below a specific income limit. These plans let you put away $2,000 per child per year.
Estate Planning and Creating a Will
Planning your estate and will are absolutely vital to ensure the safety and financial future of your children
A will doesn’t just define what should happen to your assets, it’s also a way to designate who should be the legal guardian of your child in the event you and your spouse both pass away. Without it, the state will decide these matters — and that may not fall in line with your wishes.
In your will, you also name your estate’s executor, the person in charge of managing the distribution of your assets.
While estate planning involves many important nuances, there are a few essential elements that you should know:
A beneficiary is a person you elect to receive control of funds and assets accumulated in certain accounts after you pass. If you haven’t updated your beneficiaries in several years, now is a great time to do so. Perhaps you would like to make your new child or your spouse a beneficiary.
Should your first beneficiary be unable to assume responsibility, you can often name a secondary beneficiary. That way, your assets will still end up where you want, even if something tragic happens to the first beneficiary.
Your beneficiary will possess the legal right to your accounts. Courts often hold up the beneficiary as being more formal and official than a name listed in a will. For example, if you name your spouse as your beneficiary on your life insurance policy, but you name your child as its recipient in your will, the court would recognize the spouse, since they were the beneficiary.
Naming a Guardian:
Should something happen to you, who would take care of your children? A guardian is responsible for the wellbeing and livelihood of your child. When choosing this person, think of someone who shares your views and wishes for parenting.
Establishing a Trustee:
If the guardian is responsible for the social upbringing of the child, a trustee is the financial counterpart. This person is tasked with managing your child’s money and bills. A trustee files income tax returns, invests leftover funds, and distributes money to your child.
While it is possible to appoint the same person as the guardian and the trustee, many experts say that these appointments should be given to different people who do not share a dependent relationship.
Estate planning requires a two-fold professional process and can significantly benefit from the counsel of a financial planner and an estate planning attorney.
Take Advantage of Tax Breaks for Parents
As a new parent, tax breaks might be the last thing you’re thinking about. However, the IRS provides many credits, deductions, and other breaks to offset the high cost of parenthood.
The Dependent Exemption:
As soon as your child is born, the Dependent Exemption protects up to $4,050 of your income from being taxed for the filing year.
The Child Tax Credit:
Unlike deductions, which simply reduce the amount of income to which the IRS can apply your tax rate, tax credits are applied directly to the money you owe the IRS as a way to reduce your tax bill. Additionally, many tax credits are refundable up to a certain amount — meaning that if they push your tax owed below 0, you may receive a refund for the difference.
In particular, The Child Tax Credit can represent an applied credit of up to $1,000 off your tax liability. You can claim it if you and your child meet a rather lengthy set of eligibility criteria, which include but are not limited to:
- Your child must be under the age of 16 by the last day of the filing year.
- Your child must be claimed as your dependent.
- Your child must have lived in your household for more than a period of six months
- Your child must be a U.S. citizen.
- To see a full list of requirements, you’ll want to consult the IRS’s website.
The Child and Dependent Tax Credit:
Don’t confuse this one with the previous credit — you can claim this tax break on the money you spend hiring childcare providers.
Expenses that qualify range from babysitters to nannies to daycare, all of which can represent a credit on tax liability. If you plan to claim this credit, you will need to have thorough documentation of all your care providers — including the Tax ID or Social Security Number of anyone you hire to look after your child during the filing year.
Summer camp expenses can also be eligible if the child is under 13, provided that the parent(s) is either employed, seeking employment, or enrolled in school. Just like with other care providers, be sure you have all the supporting documentation for the camp — otherwise, the IRS may deny the credit.
The Adoption Credit:
You can claim some tax breaks even if you aren’t the birth parent of your child. If you adopted your child during the filing year, you may claim the Adoption Credit, which is offered to help defray the expenses incurred during the adoption process. The average cost of adopting a child can get up to as much as $30,000 by the time you’re finished, so the IRS offers adoptive parents a credit of up to $13,450 per adopted child who meets the eligibility criteria under the Code.
The Adoption Credit isn’t the only tax break that an adoptive parent can claim — there are additional credits available for those parents who adopt a special needs child. There is also a tax break for parents who incurred expenses on an adoption that was not successful. Whatever your situation, make sure to fully explore your tax credit options so you can save money.
Filing as Head of Household:
Filing as Head of Household on your tax return provides you with certain benefits for claiming dependents. This filing status can also reduce your tax bill for the filing year. As usual, however, you must meet some eligibility stipulations to file as Head of Household — namely, that you must have incurred over 50% of the household expenses within the home where you live with your children for the filing year. Additionally, you must have resided in the home for over half of the filing year.
The American Opportunity Credit:
Education is vital — not just for your child, but for you as well. If you are attending school while raising you were raising your new child or if you are a parent with an older child attending school, education credits could be valuable to you come tax time. The American Opportunity Credit lets you claim up to $2,500 in tax credits per year for up to 4 years for qualified educational expenses such as tuition, fees, or school supplies.
You can claim this credit for yourself if you are a student and you aren’t a dependent on someone else’s return. However, you can also claim this credit once your child reaches college, as long as you claim them as a dependent on your tax return.
The Lifetime Learning Credit:
The Lifetime Learning Credit provides up to $2,000 per tax year. Although this is less potential credit than the American Opportunity Credit, it’s also less restrictive in certain areas. There’s no limit on the number of years you can claim this credit.
Managing your finances as new a new parent starts before the baby arrives and continues until they’re an adult. Careful planning and discipline can minimize stress and help you succeed.
Position yourself for success before the baby arrives by building an emergency fund, paying down debt, and monitoring your spending. Make a budget to avoid spending too much on your baby. Leave room in the budget for life insurance and create a will should you pass early. Save for your child’s education using tax-advantaged accounts, but keep up your retirement savings as well. Lastly, don’t forget about tax breaks; they can save you thousands.
As you juggle all of these tasks, keep in mind that you aren’t alone. In addition to this guide, you have the support of family and friends who have gone through parenthood before you.