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New parents need to consider raising benjamins as well as babies

3 January 2017 in Investing Insights

Key Takeaways:

  • Raising a middle-class child now costs an average of $245,340
  • Financial planning for a new baby needs to start well before birth
  • New parents need to develop plans for short- and long-term financial health

Parenthood, in a word: Overwhelming. A new baby requires 24-hour care. Frequent feedings. Even more frequent cleanups. An occasional nap, if you’re lucky. Then more feedings, followed by more cleanups, with time for an occasional nap, and so on. Most new parents can consider themselves fortunate if they can plan activities more than one day in advance. One study found the average new parent loses 44 days of sleep in the first year of their child’s life, averaging only 5.1 hours of sleep per night. [1]

No wonder many new parents put off making financial decisions. Unfortunately, procrastination doesn’t pay when it comes to your child’s financial future. The price tag of an uncomplicated childbirth in 2013 was estimated at $30,000; that figure fell to $2,200 in out-of-pocket costs for insured parents. [2] Financially, it doesn’t get much easier from there, even for uninsured parents. The U.S. Department of Agriculture now reports it costs an average of $245,340 to raise a single middle-class child. [3]

It’s possible that you’re one of the parents who can raise a perfectly normal middle-class child for less than that, but why take the chance? There are a handful of steps that new parents can take to secure your baby’s future, and they don’t have to be done all at once.

A New Budget

Any new parent who can think coherently will notice their lives were suddenly split into two distinct parts: Before Baby and After Baby. And one of the biggest indicators in those differences has been presented in an impromptu bedtime story that begins something like this: “Once upon a time — long, long ago — Daddy and Mommy had disposable income.”

That story, however, can take a quick turn for the positive if Daddy and Mommy are familiar with their spending patterns, both Before Baby and After Baby. First-time parents especially can have difficulties budgeting for a new baby. Who knows, for example, that disposable diapers can run as much as $100 per month? [4] Or that breastfeeding can save $1,733.75? [5] Or that the cost of a stroller can range from $0 for a perfectly good hand-me-down or gift to the $1,529.97 Quinny Rachel Zoe Jet Set Moodd Stroller Travel System? [6]

Setting a new budget, based upon realistic expectations, can be a financial lifesaver for new parents. Like all budgets, there needs to be flexibility since it’s impossible to predict every expense that a newborn will or won’t need. But a well-informed estimate of new costs can save new parents a lot of money – and grief – during the baby’s first year.

Reducing Debt

There’s seldom a bad time to be reducing debt, but it’s an especially good idea when there’s a newborn in the house. Look at it this way: Every dollar of debt that’s eliminated gives you another dollar for unexpected expenses. And one of the first hard lessons for a new parent is this: There are always unexpected expenses.

Ideally, debt reduction should start early in pregnancy. It’s a good idea to begin reducing expenses – cutting back on the cable bill, finding a less-expensive cell phone plan or even selling a car – and putting the money into debt reduction. There are two tried-and-true methods to reducing debt: The “debt snowball,” where debts are paid from lowest to highest balances, and the “debt avalanche,” which prioritizes paying off debts with the highest interest rates. [7] Either method can be effective. The “snowball” generally is a better tool for parents who need to be motivated, while the “avalanche” typically results in a faster reduction of debt.

Emergency Fund

Consider a startling statistic from the Federal Reserve Board: Last year, 46 percent of adults said they would have to borrow or sell something to cover a $400 emergency expense. [8] And here’s another: The median charge for an outpatient visit to an emergency room is $1,233, according to the National Institutes of Health. [9] Considering an insurance co-payment that can run as high as $150 and a bill that makes the parent responsible for 20 percent of the tab, a single ER visit can just about hit $400.

It’s possible to raise a child without an emergency fund, but it’s possible to do that in the same way that it’s possible to drive without a seat belt. In other words, it’s dangerous. And while one parent’s emergency fund may be the size of another parent’s retirement fund, it’s best if you can have enough cash set aside to keep you afloat for three to six months.

Tax Credits

New parents need to be aware that for all the expenses associated with an infant, there are a few financial benefits. Your son or daughter (known as a “dependent” by the IRS) can shelter $4,050 of your income from taxes annually until the child turns 19 years old.

Parents also catch a $1,000 break for every child. Unlike the $4,050 exemption, which reduces taxable income, the $1,000 credit reduces the tax bill itself (although only for married couples earning less than $110,000, or single heads of households who report less than $75,000). [10]

One big catch: Your baby will need a Social Security number. Generally, it’s easiest (and best) to apply for one with a birth certificate. Otherwise, you’ll likely have to apply for one and show the social security numbers for both parents; birth certificate; proof of the child’s identity, such as a hospital record that’s not a birth certificate; and proof of the parent’s identity, such as a driver’s license or passport. [11]

If you have to hire someone to watch your child while you work, you can also get a credit for as much as $3,000 in expenses per child. The credit varies between 20 and 35 percent, depending on the household income. [12]

Workplace Benefits

While you may not always view your boss as a major ally in the financial well-being of your newborn, the truth is that there are a number of employer-sponsored programs designed to ease the burden of raising a child. A major benefit is the opportunity to purchase disability insurance. While you may be perfectly healthy, 1 in 3 women and 1 in 4 men will suffer a disability that keeps them out of work for 90 days or more. [13]

Typically, employees can purchase two types of disability coverage. Short-term disability usually pays a significant amount of your usual income for about three months, and long-term disability pays 40 to 60 percent of your salary for longer periods. [14]

On a slightly less palatable note, new parents should also look into their employer’s life insurance policies. An estimated 41 percent of all life insurance policies are sold through groups, including workplaces. Many employers offer free life insurance coverage for amounts that can cover as much as a full year of income. Other policies allow employees to purchase supplemental insurance, although higher amounts generally require proof of insurability, such as a full medical exam. [15] New parents also should consider flexible spending accounts (FSAs), which have been described as “the simplest and easiest way to give yourself a raise.” [16] An FSA essentially steers money from your paycheck to a dedicated, tax-free expense, such as health or childcare. In 2017, for example, employees can set aside as much as $2,600 for health-care expenses. [17] Parents can set aside another $5,000 for child care expenses, as long as the child is younger than 13 years old. [18]

College Fund

Fewer than 30 percent of Americans older than 25 have a college bachelor’s degree, according to the U.S. Census Bureau [19] College graduates can out-earn people with only a high school diploma by as much as $500,000 over a lifetime, according to one study. [20] For some parents, figures like those make attending college non-negotiable for their children.

One of the most popular savings plans for college is the 529 plan, named after an IRS section that dedicates savings amounts to education. The plans can work like a 401(k) plan, allowing the parent to choose different investment options, or like a prepaid tuition plan, which requires the parent to pay a set amount to cover future tuition costs.

The biggest advantage to a 527 plan is that the earnings are tax-free. Thirty-two states also offer tax deductions or credits for parents who contribute to the plans. The major disadvantage is that if a child decides not to go to college and the money can’t be used for another family member, withdrawals are taxed at standard rates, plus a 10 percent penalty. [21]

Sources:

[1] Borreli, Lizette. “Your Baby’s Crying In Sleep Could Lead You To to Lose 44 Days Of Slumber In A Single Year,” Medical Daily, September 18, 2013.” [2] Renter, Elizabeth. “Medical Bills 101: From Pregnancy to Delivery,” NerdWallet, September 19, 2016.

[3] U.S. Department of Agriculture. “Parents Projected to Spend $245,340 to Raise a Child Born in 2013, According to USDA Report,” August 18, 2014.

[4] Baby Center. “Top Baby Costs and How to Save,” retrieved December 27, 2016.

[5] Hamm, Trent. “How Much Money Does Breastfeeding Really Save?” The Simple Dollar, December 10, 2013.

[6] Amazon. “Quinny Rachel Zoe Jet Set Moodd Stroller Travel System with Rachel Zoe Diaper Bag,” retrieved December 27, 2016.

[7] Becker, Matt. “5 Steps to Prepare for a Child While in Debt,” Magnify Money, October 9, 2014.

[8] Board of Governors of the Federal Reserve System. “Report on the Economic Well-Being of U.S. Households in 2015,” May 2016.

[9] Caldwell, Nolan, et al. “How much will I get charged for this? Patient charges for top ten diagnoses in the emergency department,” PLoS ONE, February 27, 2013.

[10] Choudhri, Nihara. “Tax Breaks Every Parent Should Know About,” NOLO.com, 2016.

[11] American Institute of CPAs. “When Do I Have To Apply For A Social Security Number For My Newborn?” 2016.

[12] Intuit TurboTax. “The Ins and Outs of the Child and Dependent Care Tax Credit,” 2016.

[13] Fidelity. “How to insure your paycheck,” October 26, 2016.

[14] Life Happens. “Disability Insurance: Your Options,” 2016.

[15] Cohen, Aubrey. “Pros and Cons of Group Life Insurance Through Work,” NerdWallet, December 28, 2015.

[16] Helhoski, Anna. “Should I Get an FSA?” NerdWallet, May 20, 2016.

[17] Miller, Stephen. “2017 FSA Contribution Limit Rises to $2,600,” Society for Human R6.esource Management, November 15, 2016.

[18] Internal Revenue Service. “Child and Dependent Care Expenses,” 2016.

[19] U.S. Census Bureau. “Educational Attainment, 2011-15 American Community Survey 5-Year Estimates,” December 2016.

[20] Schrager, Allison. “College Graduates Don’t Always Out-Earn High School Grads,” Bloomberg, July 15, 2014.

[21] Saving for College. “Name the top 7 benefits of 529 plans,” 2016.

 

 

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