What to Expect: Financial Planning for New Parents

The rewards of having a child are enormous, but so are the expenses. Indeed, the financial burdens of raising a child are substantial and can extend for decades, affecting almost every aspect of your financial life — from healthcare to education to tax planning and more.

Taking the time to design a plan that considers both the immediate and long-term financial needs of your child may not address all the needs of your child, but it can provide some valuable peace of mind.

In this A Closer Look, we discuss some of the most important financial steps to consider before and after the birth or adoption of your child.

Pre-Baby Planning

Think about how your financial life will change. Bringing a baby into the mix will affect your finances in ways large and small. If you are working, will you continue working, stop working, or pause temporarily? What about a spouse or partner? If only one parent will be working — even if the situation is temporary — you’ll want to consider the loss of the second paycheck and corporate benefits such as health insurance, Flexible Spending Accounts (FSAs), and retirement plans.

Consider new expenses. Beyond the relatively modest one-time cost of your baby’s birth (if you have health insurance) or the possibly higher cost of adoption, a new baby brings other new expenses, such as childcare and healthcare, and may affect decisions regarding housing and transportation. For example, do you need to think about moving to a neighborhood with stellar schools or renovating your current living space to accommodate a child? (Figure in higher mortgage payments and taxes.) And do you have the right cars for a growing family? On balance, most expenses will go up.

Depending on your situation, you may want to consider making a few adjustments to your day-to-day financial life. Perhaps you’ll want to alter some spending plans or augment income from passive sources. For instance, it may be a good time to speak with your advisors about your investment portfolios to determine if your current asset allocation or distribution plan makes sense given your new responsibilities and expenses.

Parental leave. If they’re employed, new parents generally want to take some time off from work, using paid or unpaid leave, to settle in with their new baby. There is a patchwork of different types of leave, depending upon the company and state of residence:

• Company-paid leave. You may be able to take advantage of paid leave from work. The U.S. Bureau of Labor Statistics reported that in 2021, 23% of U.S. workers had access to paid family leave.² Several states offer (or are on track to offer) Paid Family and Medical Leave (PFML) — California, Colorado, Connecticut, Massachusetts, New Jersey, New York, Oregon, Rhode Island, and Washington. PFML is also offered in Washington, D.C. PFML is funded through employer and employee contributions and the specific benefits vary by jurisdiction.
• Family and Medical Leave Act (FMLA) leave. If no paid leave is available, under the federal FMLA, companies with 50+ employees must, by law, offer 12 weeks of unpaid protected leave to parents upon the birth or adoption of a child. To qualify, you must have been with the company for 12 months and worked at least 1,250 hours; you will get a continuation of group health insurance coverage and must be allowed to return to your same job, or a job with equivalent salary and benefits. If you work for a smaller company, you may be able to take short-term disability for six or eight weeks and add on accrued vacation days and sick days. Benefits are often capped at 40% to 60% of salary. If you’re employed, talk to your HR contact before you begin your leave; if you wait until after your child arrives, you may not qualify.

Consider your childcare needs. It’s never too early to start looking into your childcare options, since high quality childcare is invariably a top priority for new parents. The first decision is what childcare arrangement will best suit your family’s needs. If you are thinking about hiring a nanny, do you want the person to live in or live out? And don’t forget that in most cases, the IRS will consider your nanny to be a household employee. If you exceed $2,400 in cash wages in a given year, which is almost certain, you will be responsible for so-called “nanny taxes” — i.e., withholding and paying social security and Medicare taxes on the nanny’s behalf, as well as paying federal unemployment taxes.³ Another option is hiring an au pair, an arrangement that can bring cross-cultural benefits while typically being less expensive than a nanny. Au pairs are foreign nationals between the ages of 18 and 26 who are admitted into the United States on a J-1 visa for a maximum stay of one year. Due to their visa status, some tax compliance responsibilities are relaxed as compared with a nanny, but care should still be taken to make sure all formalities are properly followed.⁴ In some instances, licensed childcare centers may be available within, or in close proximity to, your office or business location, and may be an option worth considering. How to find a childcare provider with the highest standard of care? You can ask for recommendations from family and friends, who can give you the benefit of their experience. There are also established agencies that place nannies or sitters, typically do background checks, and often provide training.

Review your insurance needs — both life insurance and disability insurance. Life insurance protects your family if you pass away and need to safeguard your family’s future. Proceeds may be intended to cover housing, education, and other day-to-day expenses. If you’re employed, it’s likely that your employer’s life insurance doesn’t offer sufficient coverage, and if you leave your job, you will most likely lose the policy as well. Depending on your situation, it could make sense to consider term life insurance, which provides coverage for a set number of years. Such coverage can also insure a stay-at-home spouse by covering childcare and lifestyle expenses and is relatively inexpensive.

Another option — particularly for families of wealth who may not need a term policy — is permanent life insurance, which can be used as an investment vehicle and an estate planning tool to transfer wealth to your children or other loved ones, reduce gift and estate taxes, or provide liquidity for the payment of estate taxes.

Disability insurance comes into play if one or both parents are unable to work due to an illness or injury. It will pay a percentage of your income, either short-term or long-term, ideally enough to cover any mortgage, childcare, and household expenses. If you’re employed, start by checking how much disability insurance you already have from your employer. The coverage typically provided by an employer-sponsored plan often falls short of a family’s actual expenses, so you may want to supplement that coverage with an individual policy or obtain one if you don’t have current coverage. Trade or industry groups may offer policies to their members through partnerships with insurance companies, as well.

Review your healthcare coverage. Healthcare will invariably be a big-ticket item, and even more so with the arrival of a new child. Inevitably there will be the unexpected doctor’s visits, along with higher insurance premiums, copays, and possibly even hospital stays. If you’re covered by an employer group plan (even if it’s by a company you own), you may want to review available options in terms of high-deductible versus low-deductible plans to see which make the most sense for you. Also, as early as possible, find a well-recommended pediatrician, ideally one in your network to avoid paying out-of-network fees. Another option is concierge medicine, which provides guaranteed access to doctors and personalized care — though you would still need health insurance to cover hospitalizations and specialists.

Take advantage of Flexible Spending Accounts (FSAs), if available. An FSA is an employer-sponsored program (not all employers offer the program) that allows employees to set aside funds tax free for healthcare and/or childcare expenses. Funds are withdrawn from your paycheck for deposit into your account before taxes are deducted. Typically, enrollment is only once a year during the company’s open enrollment period unless you have a “qualifying event” — like having a baby or adopting a child. There are two types of FSAs:

• A Health Care Flexible Spending Account (HFSA). An HFSA allows you to set aside pretax dollars for out-of-pocket medical expenses that aren’t reimbursed by your health insurance plan, including your family’s deductible, copays, prescription medications, and other uncovered expenses. (If you expect that your medical costs in a given year will exceed 7.5% of your adjusted gross income, you may wish to consult with your income tax advisor to determine whether it would be preferable to participate in the HFSA or to itemize and deduct medical expenses that year.) Before you make your election for the annual contribution amount, estimate how much your family will spend on healthcare over the next year; these plans are set up as “use it or lose it,” and any money not spent in the given year is forfeited, although some employers offer a grace period of a few extra months or may allow you to carry over up to $570 per year. In 2022, up to $2,850 per parent can be allocated to an HFSA.⁵
• A dependent-care flexible spending account (FSA). A dependent-care FSA can pay for eligible childcare expenses including day care, nursery school, pre-school, summer camp, and before- or after-school programs. The money generally must be spent during the plan year, or it’s forfeited. While one or both parents can have a dependent-care FSA, only $5,000 in total can be allocated to dependent-care FSAs by a family in 2022. (Note: a dependent-care FSA cannot be used for expenses for which the child and dependent care credit is claimed.)⁶

Consider a Health Savings Account (HSA). If you choose a high deductible health plan, typically covering only preventive care prior to the deductible, an HSA can be used to pay for healthcare expenses including doctor’s fees, medications, formula, etc. You can contribute up to $3,650 for an individual health plan ($7,300 for a family health plan) in 2022. Any money you contribute and don’t use can be rolled over, so there’s no risk of losing it as you would in a healthcare FSA. These plans may be available from your employer, but they can also be purchased independently.⁷

After Your Baby Has Arrived

Applications and Paperwork

Get a birth certificate, Social Security number, and possibly a passport. Be sure to fill out the birth certificate form in the hospital and apply then and there for your baby’s Social Security number. It goes without saying that a Social Security number will be critical for many purposes throughout your child’s lifetime. Also, if you think you will be traveling internationally shortly after the birth, apply as soon as you can for the baby’s passport, as it can take six weeks to process, although you can pay extra for expedited processing. And it can be a good idea to get extra copies of the birth certificate when it’s still top of mind. In the case of adoptions, a complex process beyond the scope of this paper, an amended birth certificate and other specific paperwork may be required.

Add your child to your health insurance plan. Most healthcare plans require that you add your child to the health insurance plan within 30 or 60 days after birth or adoption, or you could forfeit coverage. Typically, this means that your child will be covered retroactively to the date of birth. Adding a child to your policy means that your premium is likely to go up if you do not already have a family plan. Be sure to check with your health insurance carrier to understand how coverage will work for your new family member.

Tax Credits

The Child Tax Credit (CTC). In 2022, the Child Tax Credit is $2,000 per child under 17 with an income phase out of $200,000 for individuals and $400,000 for joint filers. The CTC is a dollar-for-dollar reduction of your tax liability rather than a deduction.⁸

The child and dependent care credit. People who pay for childcare so they can work are eligible for the child and dependent care tax credit tax credit. For 2022 or later, this is 35% of qualifying expenses up to a maximum of $3,000 for one child or $6,000 for two or more children, for maximum credits of $1,050 and $2,100, respectively. The credit begins to decrease at annual adjusted gross incomes (AGIs) of $125,000 and reaches zero at $438,000.⁹

Estate Planning

The birth or adoption of a child is a good time to put an estate plan in place, if you don’t have one. If you already have an estate plan, the arrival of a child is a good time to revisit it.

Make sure you have a will. Before or soon after your child is born or adopted, it’s important to have a will in place. You should choose an executor and clearly specify how your assets are to be distributed between any surviving parent and the child. (You’ll want to review your plan again if you have another child.) It’s also highly recommended to have a designation of healthcare proxy (referred to as a health care agent in some states), a living will, and a power of attorney for financial decisions if you were to become incapacitated.

Choose a guardian for your child. In addition to having an updated will in place, you should address the important decision of choosing a guardian who will raise your child if both parents are deceased. In the absence of this designation, the courts would decide who will care for your children, and how your assets will be managed and passed on to them. And without an estate plan in place, your child or children are likely to get full control over their inheritance when they reach a certain age, usually 18. By preparing an estate plan, you will have control over the manner and timing in which your children receive their inheritance.

Review and update your beneficiaries. The people you designate as the beneficiaries on your retirement plan and life insurance will inherit your assets if you die, even if those designations are out of date. Make sure to update those documents to ensure that your assets will be passed on in keeping with your wishes. It is fairly typical to name your spouse/partner and/or children as the beneficiaries of your accounts, although other designations are also possible, including charities, trusts, or other important individuals in your life.

Consider establishing a trust for your child. Among their many benefits, trusts can protect assets for your child today and down the road — from probate, from creditors, in the event of divorce, and more — and ensure your wishes are fulfilled.

Contact your advisors. If you haven’t already done so, make sure that your circle of advisors, including your Bessemer client advisor team, lawyers, and accountants are all aware that there’s a new member of the family so they can help with additional planning.

College Planning

As a parent, you’re probably looking at four years of college tuition or more and possibly graduate school tuition as well. And add pre-school and K-12 expenses if you choose the private school route. Not just parents, but grandparents and others, often want to contribute to funding educations. You’ll want to find the most tax-efficient way to pay for school expenses taking into consideration the impact of federal transfer taxes (estate, gift, and generation-skipping) taxes. Here are some tax-smart options:

• Direct payment of tuition. The most straightforward way for parents or grandparents to pay for college is to make payments directly to the school, whether primary, secondary or college. The main advantage is that there is a gift tax exclusion for tuition payments, and it is unlimited — these payments don’t count against the annual gift tax exclusion (currently $16,000 per donee per year) or the lifetime gift tax exemption (currently $12.06 million). These tax advantages only apply to tuition, not room and board, which could be covered by outright gifts up to the annual exclusion amount, and if necessary, supplemented with gifts that use lifetime gift tax exemption and generation skipping transfer (GST) tax, if applicable.
• Custodial accounts (UGMAs or UTMAs). These accounts, named after the Uniform Gifts to Minors Act and the Uniform Transfers to Minors Act, are easy to establish and enable parents and grandparents to take advantage of the gift tax annual exclusion and grandparents to take advantage of the GST tax exclusion (also $12.06 million). Once open, anyone can make unlimited contributions, though contributions exceeding the annual exclusion will either use exemption or cause gift (and possible GST) taxes if no exemption remains available. There are some drawbacks: contributions are irrevocable, the beneficiary cannot be changed, and the money generally belongs to the child automatically at age 18 to 21, depending on the state. (A handful of state UTMAs, at the time the account is set up, allow the donor to opt into a later termination age, up to age 25.)
• 529 plans. These plans are tax-advantaged tuition savings plans that work like retirement plans. A 529 plan can be used for qualified educational expenses for college or graduate school, and up to $10,000 per year for elementary and secondary education. Contributions can be excluded from gift tax up to the annual exclusion amount; in addition, it is possible to “superfund” a five-year upfront contribution ($80,000 per single donor and $160,000 for couples at 2022 annual exclusion amounts) per beneficiary; even though such a contribution would incur no gift taxes, it does require the filing of a gift tax return. Additionally, some states offer state income tax benefits for participating in their local 529 plans.
• Minor’s trusts and Crummey trusts. Trusts provide more flexibility than 529 plans because the trust funds can be used for any purpose, rather than solely for education. Gifts to the trust are irrevocable and the trustee maintains control of the trust. Minor’s trusts must distribute the entire trust assets to the beneficiary at age 21, or otherwise give the beneficiary an opportunity to withdraw the assets for a period following his or her 21st birthday. Crummey trusts work a little differently, and instead give the parent (while the beneficiary is a minor) and the beneficiary (after attaining age 21) a period in which they may withdraw amounts contributed each year, allowing these gifts to qualify for the gift tax annual exclusion.

For additional information on planning for college, see our A Closer Look “Tax-Smart Approaches to Funding Education.”

Conclusion

Few life decisions are as gratifying as having a child. But with a baby’s arrival, you have entered a new world of important decisions, both immediate and long term. This is a good time to review existing plans and make new ones, and expert guidance is essential. If you are interested in discussing ways to create a secure future for your new child, including ways Bessemer Trust can help, please contact your client advisor.