It can be scary, we know. Making sure you have enough money – not just for the hundreds of diapers your baby will need in his first three months of life but the hundreds of books he’ll need at college 18 years from now — is daunting. That’s why we listened to your biggest concerns when it comes to saving for your family’s future and created this guide to demystify some of the most common (and confusing!) money matters. Start your financial plan today!
1. My husband and I just had a baby girl and are a bit overwhelmed by all the financial considerations for new parents. What’s the first thing we should do?
First of all, enjoy your new family. Secondly, make a will. Regardless of your age or economic situation, it’s a must. Few things are worse than compounding a tragic situation with needless complications and legal hassles for surviving family members. If you don’t have an attorney or the funds to hire one, there are plenty of online and do-it-yourself resources out there to help you draft a simple, efficient, and legally viable document (sometimes in just a matter of minutes). Check out www.legacywriter.com, www.buildawill.com or www.nolo.com for starters. Consider it a down payment on peace of mind.
Brian O’Connell, a freelance writer in Pennsylvania, is the author of Free Yourself from Student Loan Debt.
Making Ends Meet
2. My husband and I already struggle to make ends meet every month. Now we’re pregnant and wondering how we’ll manage when the baby comes. What’s the best way to handle the costs, both short- and long-term, of a newborn?
The current government estimate for raising a child to the age of 18 is $170,000. But don’t panic: That’s over a period of almost two decades. To handle the immediate costs of a new child, you’ll need to craft a budget, listing every single item and service you currently spend money on during the month.
Once you know where your money goes sans baby, you can revise your current figures to accommodate another mouth to feed. The U.S. government bases its calculation for raising a child (that scary number from above) on seven basic categories — food, housing, transportation, clothing, health care, childcare, education, and miscellaneous goods and services — so be sure to include them in your new budget. Ask other parents for help in figuring out how much you might expect to pay for clothing, food, etc. Will your baby be inheriting hand-me-down layette items from an older cousin or friend? How much baby gear (strollers, car seats, cribs) do you expect to receive as gifts? How much will you purchase yourselves?
Total your amounts by category (the seven listed above, plus any others you’ve added) over the course of a year, factoring in such occasional expenses as taxes, car repairs, gifts, and vacations; you can work from a calendar to mark when these expenses are due. Then divide your amounts by twelve to reach your monthly budget figure.
If you’re like most people, you’ll need to cut back in some areas of your current budget to make room for the new baby. (Entertainment may be first to go, at least until you get some sleep!)
Once you’ve figured out how to make your baby budget work, you can take a deep breath and start thinking about the long term. Set aside whatever percentage you can reasonably afford each month toward mutual fund investments, preferably with a fund that leans more toward stocks than bonds. It may seem a long way away, but if you’re hoping to pick up the tab for major life events like college or a wedding, it’s never too early to start saving.
* BabyTalk tip: Don’t forget such “hidden” expenses as maternity clothing, diapers, formula (if you’re not breastfeeding), and several additional loads of laundry per week when constructing your budget.
Work vs. Stay-at-Home
3. We’re due to have our first baby in six weeks. My husband and I both work, but it seems like most of my salary will have to go towards childcare. Is it worth it, financially, to continue working?
Aside from the emotional and psychological issues (the importance of working vs. staying at home to you personally), you’ll want to factor in the financial pros (insurance, health care, retirement plan, bonuses, etc.) and cons (commuting costs, wardrobe, etc.) of working and weigh them against the financial pros and cons of childcare. Will you hire a nanny? Use daycare? Rely on family members?
In a recent Children’s Defense Fund survey of childcare centers in major cities and suburbs, the weekly cost per toddler ranged from $115 to $175; in rural areas it was $65 to $90 per child. Other studies say that the average cost of childcare is $5,000 a year, while a personal nanny may run you $20,000 or more a year.
Because of the high costs, you’d have to make more than $25,000 a year for continuing to work to be financially worth it, say many financial planners. Bear in mind that many employers offer flexible spending accounts that help cover dependent-care costs, using pre-tax dollars deducted from your salary. If you don’t have one of these accounts, you may qualify for a Dependent Care Credit on your tax return. Also, the Child Care and Development Fund provides subsidized childcare to eligible families.
Health Care Costs
4. Will our health care plan costs rise once our baby arrives? How much should we expect to pay?
Check with your employer to determine how the addition of a new family member will affect your deductible and monthly fees. Many health care companies have family plans with a set monthly premium that covers an entire family, up to a certain amount. No matter what your plan, it’s best to factor an extra $30 to $60 in higher premiums and another $50 to $80 in uncovered medical costs for your child into your monthly budget.
* BabyTalk tip: Before your baby arrives, check into your health care provider’s plan and make sure she will have coverage as soon as she is born. (Some plans don’t pay until a child reaches 6 months of age.)
Flexible Spending Accounts
5. A friend at work tells me that when she had her baby, she and her husband opened a spending account through our employer that enabled them to pay medical bills with pre-tax dollars. That sounds like a good deal, but what account is she referring to?
Your friend is referring to a flexible spending account (FSA). As a result of the new tax laws enacted in 2003, more and more employers are now offering FSAs as an attractive benefit that allows employees to pay for out-of-pocket medical and dental expenses on a pre-tax basis, using money set aside from each of their pay periods.
Here’s the skinny: You contribute a specific amount from your paycheck into an account to pay for eligible health care and childcare expenses. These typically include copayments and deductibles, dental care, prescription drugs, eyeglasses and contact lenses, flu shots, counseling, chiropractic visits, and birth control, as well as licensed daycare or nanny services. Since contributions are exempt from federal, state, and payroll taxes — just like the money you save in a 401(k) or other retirement plan — putting money into an FSA can cut the total cost of your eligible out-of-pocket medical expenses by a third or more.
Plus, a recent Internal Revenue Service (IRS) ruling established that nonprescription drugs (everything from cold medicine to heartburn relievers) may also be covered; check with your employer to see if they’ve added this to their list.
* BabyTalk tip: Be careful when estimating how much to set aside each pay period; FSA dollars are offered on a strict use-it-or-lose-it basis. Any money left over in your account at the end of the year goes back to your employer – not you. For help figuring out how much you’ll need without overestimating, use this health care-cost calculator.
6. Do we need an emergency fund? How much should be in it? And what’s the best way to save for it?
Yes, ideally you should aim for approximately $10,000 to $15,000 in emergency savings. Consider it your “just in case” fund. Just in case you or your spouse lose your job, you’ll need at least three months of living expenses as a cushion. Or just in case the alternator on your car goes kaputz, you’ll need cash to have it replaced. Emergency savings can also be used for necessary home improvements and other unexpected expenses that life will inevitably throw your way.
Saving for such a fund can be a catch-22 situation: You want to establish savings quickly, but you don’t want to be so aggressive in the process that you risk losing money (by pouring cash into a declining stock market, for example). Try instead to cut household expenses first (nonessentials like pricey vacations, dinners out three times a week, that new sound system for your car). Also, aim to cut 10 percent out of your monthly budget and earmark it for your emergency fund. It’s more doable than you might think.
* BabyTalk tip: Set aside any windfall money, such as cash gifts for your new baby, workplace bonuses or raises (there’s no rule that says you have to spend a raise) and plow it into your emergency fund.
College, Debt, or Retirement?
7. What’s more important: saving for college, paying off debt, or saving for retirement?
Actually, establishing an emergency fund trumps all three. If something bad happens — a job loss or an illness, for example — you’ll need those emergency funds to live on. Once you’ve got that established, you can move on to your other family financial obligations.
Tackle your debt first, but keep in mind that there are two types: “good” debt (college loans that will get you farther in life, for example) and “bad” debt (credit card debt with interest rates of around 18 percent that can suck the marrow out of your household budget in no time flat). It’s the latter, pit-in-the-bottom-of-your-stomach type of debt that you want to start to eliminate as soon as you can.
The average annual credit card debt per U.S. household is $8,000 and rising. If you’re working on paying yours off, carry a single credit card and use it only in case of emergencies. And that 10 percent of your monthly household budget you were putting towards your emergency fund? Use it now to pay your creditors.
Once you’re paid off, you can begin to work on your retirement steadily — through a 401(k) and/or other investments — before you pour all your money into college savings. There are various options to help pay for higher education (financial aid, scholarships, etc.), but no one is going to loan you the money to retire on and you don’t want to be a financial burden to your child as you get older.
8. What’s the best way to start saving for our child’s college education?
Recent tax law changes make it possible to save for your child’s college education free of tax through a College 529 Savings plan (sometimes known as a Qualified State Tuition Plan, or QTSP) which allows you to earmark money specifically for a child’s higher education. The earnings on regular investments and savings accounts are taxed every year, making the tax-free 529 plans a great deal. They’re also highly flexible — since the funds aren’t restricted to minors, you can also apply them to graduate school for your child (or yourself).
Another option: You can give up to $11,000 per year ($22,000 if you give jointly with your spouse) to a child without incurring any gift tax liability as part of the Uniform Gifts to Minors Act. If the money is reinvested, the earnings will be taxed at the child’s (likely) lower rate. Although this move should cut your family’s annual tax bill, keep in mind that once your child turns 18, she is legally free to spend the money as she chooses, which may or may not be on college.
Whatever your plan of attack, be an early bird. The sooner you start to invest money and earn interest on it, the better your child’s educational future will be.
Declaring Your Newborn
9. I understand that my wife and I can declare our newborn child on our tax returns this year. How can I do that?
Yes, it’s true: Having a baby reduces your tax burden by $3,100, according to the IRS. No matter when your child’s birthday is, you’ll receive an extra personal exemption on April 15th. In order to claim this exemption, your child must have a Social Security number, so be sure to apply for one as soon as your little dividend arrives. (You will probably get the form at the hospital; if not, you can apply at any Social Security office, or download the application form.)
Having a child may also qualify you for certain tax credits, depending on your income level. Check with your accountant or the IRS to see which ones you’re eligible for:
1. The Child Tax Credit is $1,000 per child, so if your tax form shows you owe federal income taxes, you would subtract that amount. You qualify for the Child Tax Credit if your adjusted gross income for the year comes in under $75,000 (or $110,000 if you are married and filing jointly).
2. The Earned Income Tax Credit is a credit for low-income workers that reduces the amount of tax you owe and may even give you a refund. The 2004 income limit for single working taxpayers with one child was $29,666 ($30,666 if married and filing jointly) and $33,692 for employed single parents with more than one child ($34,692 if married and filing jointly).
3. The Dependent Care Credit may also reduce the amount of tax you owe. You’re eligible if you and/or your spouse are working, looking for work, or in school, and are paying someone to take care of your child. The caregiver cannot be someone you can claim as a dependent, and he or she must provide you with a taxpayer ID or Social Security number.
* BabyTalk tip: You will likely have to choose between using either the Dependent Care Credit or a Flexible Spending Account to pay for your childcare expenses. The Dependent Care Credit is usually the better option for families with annual incomes of around $30,000 or less. Always consult with a tax preparer for complete and personalized tax advice.
Increasing Life Insurance
10. Should we increase our life insurance now that we have a new baby? If so, by how much?
A good rule of thumb when you’re adding a child to the mix is to raise your insurance from about three to five times your annual household income. Term insurance is your best bet; it gives you the most bang for your financial dollar. Disability insurance is also well worth considering.