I remember the moment my wife told me she was pregnant. She shook me awake one Saturday morning, tears of happiness in her eyes. After my heart, nerves, and emotions calmed down — I thought someone had died with the ferocity of her approach — the wheels started spinning. Will we be good parents? What can we do to get ready for this?
The next few days and weeks were a blur, and we relied on well-intentioned but scattershot advice from close family and friends on what to do to properly prepare, from cribs to clothes to car seats. In retrospect, I would have loved to have a comprehensive list of all the things that one needs to do to prepare for a new baby.
While this blog post couldn’t possibly summarize everything required to bring a child into the world, we can give a quick-hit checklist to prepare your financial lives for your newborn.
1. Make a (Pre- and Post-) Baby Budget
Newborns are beautiful, miraculous, and life changing. They are also messy, loud, and expensive. A study done in 2017 showed that expenses for a baby’s first year can range from $20,000 to $50,000!
There’s a lot to purchase, but before you rush off to buybuy BABY, start making a plan for how you will incorporate all of your little one’s financial needs into your income and savings picture. There are several calculators and other online resources that dive into this in more detail. Harbor Crest Wealth Advisors also works with new parents to help them build a budget that fits their goals, needs, and lifestyles.
2. Build Your Emergency Fund
Previously, you may have been able to weather a job loss or income reduction by dramatically altering your lifestyle. But this changes, considerably, when you have to care for another person, one that seemingly needs 24/7 care and attention.
Now is the time to start building your emergency fund, if you don’t have one already. Your goals for your emergency fund size will vary based on your profession and needs, but six months of expenses is a good initial target.
With an emergency fund in place, you can sleep a little more soundly (to the extent you sleep at all) knowing you can ride out a rough patch during a very challenging time for you and your spouse.
3. Update Your Estate Plan
Updating your estate plan is arguably the most important point on this list — yet often the most overlooked. No one likes to consider what should be the unimaginable. But you put your family’s future at serious risk when you don't spell out what to do if the worst happens.
Building a complete estate plan is an involved process, but at a minimum make sure you have a will in place that names a guardian for your child. Additionally, make sure that person is indeed willing and able to take on this responsibility.
There is a fair bit more to building a proper estate plan, from setting up trust accounts to naming an executor of your will to establishing durable powers of attorney. Given the complexity involved, consult with your legal, financial, or tax advisors to build a comprehensive estate plan.
4. Review Your Insurance Coverage
Properly protecting your downside from tail risks is critical now that you are solely responsible for another life. What would happen to your family if you passed away or became disabled? Who would support the household?
Insurance planning is another complicated topic. At a minimum, though, make sure you research your income replacement options, such as term insurance and your short- and long-term disability coverage.
Insurance needs vary by individual and family circumstance, and it’s important to find the right insurance advisor who will work to understand your needs. Make sure they are willing to spend time to get to know you, and don’t be afraid to ask questions about coverage and costs.
5. Start Saving for College
College inflation rates stand well above the general inflation rate as well as average increases in income. The ten-year historical rate of tuition inflation is around 5 percent.
What does this mean, in practical terms? If college tuition inflation remains 5 percent for the foreseeable future, then by the time your newborn is ready to head off to college, tuition will be 2.4x higher than today’s costs.
There are many options to prepare for college costs, and we will have a blog series on education planning later this year. That said, two popular vehicles are the 529 plan and, for those of us in Florida, the Florida Prepaid college savings plan. The 529 plan allows you to save and invest post-tax funds for your child’s future without paying federal taxes on earnings that are used for qualified educational expenses.
6. Take Advantage of Tax Credits
A new child brings so many wonderful things to the world… including tax credits! While the Tax Cuts and Jobs Act of 2017 got rid of exemptions, it did allow for child-related tax savings. The Child Tax Credit (CTC) allows families to deduct up to $2,000 per qualifying dependent child (16 or younger), and up to $500 nonrefundable credit for qualifying dependents other than children.
There are some parameters to keep in mind. For instance, you have to provide at least half of the dependent’s support during the year (with exceptions, of course), the child cannot file a joint return, and the child has to be 16 or younger by the end of the calendar year.
Additionally, there are income limitations: $400,000 for those married filing jointly, and $200,000 for all other filing statuses.
7. Max Your HSA Contributions
Health savings accounts (HSAs) are a wonderful savings vehicle, offering “triple” tax advantages of 1.) deductible contributions, 2.) tax-deferred earnings growth, and 3.) tax-free withdrawals for qualifying medical expenses. If your company offers a high-deductible health plan, you can contribute to an HSA.
While proper health care planning for a new child involves more than just tax considerations, the ability to defer up to $7,100 in 2020 (for family HSA plans) is an underappreciated asset. By maxing out your HSA contributions, you effectively can purchase qualifying infant necessities at a discount.
8. Contribute to a Dependent Care FSA
Dependent care flexible savings accounts (FSAs) allow you to defer up to $5,000 (married filing jointly) in pre-tax dollars to be used for qualifying childcare expenses. These types of accounts are sponsored by employers, and contributions are automatically deducted from your salary.
The expenses covered are broader than you may think, and include before- and after-school care, babysitting and nanny expenses, daycare, nursery school, and preschool, as well as summer day camps.
Unlike the HSA, though, dependent care FSAs are “use it or lose it” each year (some plans allow for a small extension or rollover of $500, though that’s not required).
9. Save for Your Future Retirement
It’s easy to get wrapped up in planning for your little one, but don’t forget to think of your (financial) self, either. The road to financial independence starts with slow incremental saving during your working years.
At a minimum, make sure you are taking advantage of your company match in your 401(k). The next step is to start saving at least 15 percent of your pre-tax salary, ratcheting that saving percentage up over time.
Plan Your Family’s Finances with Harbor Crest Wealth Advisors
For me and my wife, the months leading up to our son’s birth were exhilarating and hectic. We had lots to do, and the clock kept ticking despite our best efforts to find more time. I spent countless hours in Excel, trying to model out our cash inflows and expected outflows once the little man arrived.
Thankfully, today, we have more focused tools to help plan for such an exciting time (my Excel wizard skills notwithstanding). If you would like to get a head start on planning for your child, then try out our financial planning tools today.