Baby On Board

My wife, Kimberly, and I have been preparing for our first child, due very soon. Like many expectant parents, we handled the basics: painted the baby’s room, bought furniture, shopped for bottles and bibs and visited daycare facilities. However, because as a Moneta Group Family CFO I spend my days thinking about how families consider their long-term financial planning, we’re also spending time thinking about how our new little one will impact our financial future. I’d like to share some of our financial planning with you and offer some tips that parents (and grandparents) may find helpful during this very exciting transition.

Review the balance of your emergency fund.

These are dollars that should be easily accessible in the event of an emergency, such as job loss or medical catastrophe. A good rule of thumb is to maintain at least three to six months worth of living expenses instantly available in a money market or savings account. With a baby on the way, you should consider those anticipated monthly costs (day care, formula, clothing, etc.) and add this to your emergency fund. If you don’t have an emergency fund, you need one. Is there money somewhere that can be used for this purpose? If not, you should start building your emergency fund today.

Perform a thorough analysis of the health insurance options for your baby.

If you are covered through an employer-sponsored plan, inquire about family coverage options to include children. If both parents work, review the coverage options offered by both plans. The comprehensiveness of each plan will likely differ, and some employers may even offer to cover a portion of your child’s health insurance costs.

Maximize the use of your flexible spending account for child care (if available) through your employer. A flexible spending account is a tax-advantaged account that many employers offer via a ‘cafeteria’ plan. In a flexible spending account, an employee may defer a portion of pre-tax earnings (up to $5,000) for the purpose of covering qualified dependent care expenses. By taking advantage of a plan like this, you may be able to avoid normal payroll taxes on current earnings, which can amount to a significant tax savings for many participants.

It is important to note that dependent care expenses paid via a flexible spending account are not eligible expenses for calculating the Child and Dependent Care Credit on your Federal Tax Return, an option that may be more beneficial for tax payers in lower tax brackets. It is also important to note that this planning strategy is a “use it or lose it” approach: dollars contributed to your flexible spending account in a given tax year must be used by the end of the plan year and cannot be ‘held over’ for subsequent years.

Obtain (or review ) your estate planning documents.

It’s something we don’t like to think about, but having a plan in place to protect your child in the event of your death or incapacity may be even more important than having a long-term financial plan. Basic estate planning documents that include a Will, Durable Power of Attorney and Health Care Directive are important for everyone to have, particularly parents of young children. These documents can be drafted to include decisions about who will care for your child should you not be able to and how your assets should be protected for your child’s benefit. Developing and periodically reviewing your estate plan with your attorney is an important aspect of any comprehensive financial plan for your family.

Start to think about education funding now: Educations Savings Accounts (ESA) and 529 Savings Accounts.

Although it may be years away, it is never too early to begin thinking about funding your new child’s education, particularly if you think you may want to send your child to private elementary or secondary schools . A Coverdell Education Savings Account (ESA) is a great way to begin preparing for these expenses. An ESA is a tax-advantaged investment account similar to the more popular Section 529 college savings plan. Like a 529 plan, the balance in an ESA may grow tax deferred, and, if used for “qualified” education expenses, these earnings may be withdrawn tax-free. And like a 529 savings plan, grandparents can also set up an ESA for your child—something they may be excited about doing.

One of the benefits of an ESA over a 529 plan is that ‘qualified’ expenses include those incurred in elementary and secondary school whereas a 529 plan considers ‘qualified’ expenses only those incurred at a college or qualified post-secondary school. An ESA allows saving toward the potentially significant expenses of private elementary and high school tuition. Unfortunately, contributions to an ESA are limited to $2,000 per beneficiary in a given tax year, and certain donors may be limited (or excluded) from making contributions to an ESA based upon income limitations ($110,000 for single tax payer and $220,000 for married filing jointly).

If building a nest egg for college is one of your primary objectives, consider the merits of establishing a 529 college savings account. For many parents, funding a child’s college education will be one of the single largest expenses they face. A four-year University education can exceed $250,000, depending upon the school your child attends, and a 529 college plan is great way to begin working toward defraying a portion of this lofty expense.

A 529 account is similar to the Education Savings Account (ESA) in that dollars contributed are eligible to grow tax-free if they are used for ‘qualified’ education expenses. Unlike the ESA, contributions to a 529 are limited only in that they cannot exceed the amount necessary to provide for the qualified education expenses of the beneficiary (be aware of gift tax consequences however for contributions exceeding $13,000).

In many states, including Missouri, state income tax deductions or credits are available to those who establish one of these plans. In Missouri for example, an account owner may deduct up to $8,000 for contributions made to the account. Married tax payers may deduct up to $16,000, even if only one spouse has income. These accounts are simple to start and many plans require only a nominal initial contribution—and 529 accounts may be opened by anyone, including grandparents and aunts and uncles.

I have been told that the birth of your first child is the most exciting time of your life, and while we are excited about the future, the financial preparations for the birth of our child can feel a bit overwhelming—even for someone who thinks about these issues daily. If you take some time now to begin planning for your baby’s future, you will be ready to enjoy the arrival of your new family member and will be well on the way to a good plan for today, tomorrow and the years to come.

Bill Dickens, CFP®

Bill is the professional consultant for Doug Weber.

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