Financial Tips to Know When You Welcome a Baby to the Family
Ryan Munroe, CFP®
My wife and I recently welcomed a new addition to our family, a baby boy that we couldn’t be more excited about. Adding a chair to the dinner table can be a tremendous source of joy and also some anxiety. As a new father and also a financial planner, I wanted to be sure that I was making the right financial plans for our son’s future. The following are insights that have helped my wife and I ease those new-parent tensions and make this major life transition go more smoothly.
Life Insurance
It’s hard to think about, but the single most significant risk to a young child is the loss of one or both parents. The emotional damage is devastating; however, the financial loss can have an equally adverse effect on the surviving parent or parentless child. Though losing both parents is unlikely, the first step to mitigate the risk is to appoint a legal guardian. Careful consideration should be taken in appointing a guardian. The appointee should be included in the discussions to ensure that everyone knows what the intentions are and that they are willing and able to take on the responsibility.
Most financial risk can be mitigated with a level term life insurance policy, which guarantees insurability and a fixed premium for the period. Fixed terms of 10 to 30 years are typically offered, although a 15 to 20-year period may be best when looking to cover the child’s most vulnerable years. Rates can be quite attractive when combined with existing policies.
Life insurance will cover the untimely death of either/both parents. However, with careful planning and budgeting, a plan can be turned upside down if a parent is unable to work due to illness or injury. This risk can be abated through disability insurance. The first step is to review any potential coverage that is offered through your employer.
The coverage will provide a percentage of your pay for either short term (3 to 6 months) or long term (6+ months) coverage, after an elimination period. You will need to have adequate liquid savings to cover the elimination period. If your employer does not offer coverage or you would like to add supplemental coverage, you can purchase a private policy. When analyzing coverage amounts, keep in mind that expenses will increase with the addition of a newborn, presenting an opportunity to decrease all coverage premiums by bundling plans.
Estate Planning
With a funded life insurance policy and guardianship in place, make sure to review the beneficiaries on all accounts and create a will. Most people name their surviving spouse then children as beneficiaries in that order. You can also name a separate guardian of the estate to safeguard the assets for adolescent children.
A will provides a documented reference of your guardianship and contingency plans, which can help avoid potentially lengthy and costly legal battles. During your lifetime, the will can be updated at any time. Revisit the details of the will whenever there is a change to your family dynamic. It is highly recommended to work with an estate planning attorney to establish guardianship and a living will.
529 plans
A powerful way to set up your children and family for financial success is with a college savings account. A 529 plan is a savings vehicle to fund qualified education expenses. Contributions are made and grow tax-deferred. Several states, including Arizona, provide some state tax deduction on contributions. Distributions that are made for qualified education expenses are exempt from both federal and state income tax. Qualified distributions can include tuition for college, university, trade, and vocational schools. Equipment, supplies, and other various educational expenses are also considered qualified expenses. If one child requires more assistance, beneficiaries can be changed, including passing the 529 plan on to the next generation.
Our family has used 529 savings vehicles to deposit birthday checks from family and friends and also offer an alternative to relatives shipping toys across the country. This solution has the added benefit of cutting down on the excess clutter of toys. Even modest contributions can have a profound compounding effect over 18 to 20 years. Your financial advisor can help you determine the best 529 plan for your circumstances.
Health Savings Account
If you add your child to a high-deductible health insurance plan, you may be eligible to open a Health Savings Account, or HSA. An HSA allows for pre-tax contributions to grow tax-deferred, while distributions made for qualified medical expenses are tax-free. A unique benefit of the HSA is that the balance carries forward from one year to the next. We hope that the funds will forever go unused, but in the event of a future medical event, the funds will compound to help cover the expense.
Some employers offer HSAs as part of a benefits package. If you would like to open one independently, there are several providers from which to choose. Look for a provider with little to no account level fees, and that has a trading platform allowing commission-free trades. You will want to direct your investments the same as with any other brokerage platform. As of 2020, the IRS allows up to $3,550 in contributions for individual HSA accounts and up to $7,100 for family plans.
Flexible Spending Account
A Flexible Spending Account or FSA is a savings vehicle that houses pre-tax dollars deferred from your paycheck. The caveat with an FSA is that the money is use-it-or-lose-it, meaning, it does not roll over from one year to the next. Two types of FSA’s are beneficial when adding a new child:
A Dependent Care Flexible Spending Account (DCFSA) is used to offset childcare costs for children under the age of 13. The account may be offered through your employer as part of your benefits package. You can defer up to $5,000 of your annual salary into the account. Once the account is established, you will cover your childcare expenses out-of-pocket with your after-tax money then submit it for reimbursement from the accumulated pre-tax deferral.
Essentially, this plan makes up to $5,000 of annual childcare coverage income tax-free. If you are in a 24% marginal federal tax rate, it’s the equivalent of putting $1,200 (5,000 x .24) back in your pocket each year. In our family’s experience, childcare costs compound more quickly than FSA deferrals. Plus, you get a small grace period at the end of each year, so you won’t be at risk of losing any benefit at year-end.
If you would like to save additional money for healthcare costs but are ineligible to open an HSA because you are not in a high deductible healthcare plan, you could be eligible to open a Healthcare Flexible Spending Account, or FSA, through your employer. The FSA ties together the characteristics of an HSA and Dependent Care FSA, but is much closer in nature to the latter. The limits are lower than the Dependent Care FSA, where currently, a total of $2,750 can be deferred annually. This money can be used to cover deductibles, copayments, and some other health care costs. The plans are still subject to the same use-it-or-lose-it restrictions.
Protecting identity
Protecting your children is one of the most important jobs a parent can have. Unfortunately, a child’s identity can represent a clean slate for fraudsters. These fraudsters can potentially use a child’s identity for years before detection. We recommend placing a freeze on your child’s credit to help protect them from identity theft, including financial aid fraud. The good news is that all three credit bureaus will place a freeze on minor’s credit files if requested:
Getting your child a passport is an ideal opportunity to establish their photographic identity, which is tied to their Social Security number and fingerprints. The US issues passports to children under age 16 with the consent of both parents.
Home security
Another area we became aware of as parents of young children was our physical space. We installed a fully integrated home security system. Each door is now equipped with a sensor and a unique sound that indicates an incoming intruder or an outgoing child. The system offers a doorbell camera that is accessible through an app for visual surveillance and two-way audio. The combination provides the appearance of being home, managed from anywhere in the world. A discount on homeowners’ insurance and waiver of a deductible on burglary claims is provided with an installation certificate.
The arrival of a new baby or adopted child reminds us of the fragility of life and that no one is invincible. And while becoming a parent can feel overwhelming at times, making smart financial decisions for your family can give you peace-of-mind from knowing that you’re doing the right things to protect their future.
Ryan Munroe, CFP®
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