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The arrival of a baby is an exciting time for a family. Not only does the birth of a child bring many of exciting firsts—baby's first smile and baby's first trip to the park, among many others—it also involves a radical lifestyle change for most households. In addition, the birth of a new baby brings additional financial challenges and decisions for the whole family. Below, we've outlined four key financial considerations to help new parents prepare for many of life's unknowns.
Prepare for the Unexpected
Baby-proofing your home may be on your to-do list, but electric sockets and mini-blind cords aren't the only risks you need to guard against once a new baby comes into your life.
Start by checking your individual health insurance policy for specific guidelines on adding coverage for your newborn. Most plans give parents 30 days after the birth of their child to add him to their health insurance plan. Missing this deadline may require waiting until the next annual enrollment period to add your baby to your plan.
And now that you have one or more who depend on you to provide for them financially, it's important that both you and your spouse purchase life insurance as part of your lifetime financial plan. Click here for an insurance calculator that will provide an estimate of how much you need in life insurance. For new parents, financial planners often recommend a term life insurance policy. With such policies, you can purchase coverage for a fixed term—as little as one year or as long as 30 years. You can choose a term that will provide coverage from the time your child is born until he has finished college and is no longer in need of financial support. (Spouses who don't work outside the home should also consider life insurance, because hiring full-time child care would likely entail substantial costs.) Some term life policies allow you the option of converting to a whole life universal or variable life policy after term coverage ends, but keep in mind that transitioning to a permanent type of policy will typically result in higher costs.
In addition to purchasing life insurance coverage, households with new babies should also consider purchasing umbrella liability insurance, particularly if you're hiring an in-home caretaker for your baby. Such policies seal any cracks that aren't covered by your primary policy and can provide additional protection in case an accident occurs on your property or if you are sued.
On the other hand, skip insurance that you don't need. Insurers may try to persuade parents to purchase insurance for their children. Unless you depend on your children for financial help, insuring young children is usually unnecessary.
Kick-Start Your College Savings Plan
College may seem like a distant speck on the horizon, but funding your child's education is one of the most significant financial responsibilities parents face. Thus, it's best to start saving as early as possible rather than fretting about scraping together tuition costs when your kids are in high school. Investing in a plan regularly—and as early as possible—will allow the money to compound over a longer period of time, which means less borrowing down the road.
There are numerous college-savings vehicles, but the most compelling ones offer attractive tax advantages. State-sponsored 529 plans have built-in tax incentives, and the age-based all-in-one 529 options allow you to invest money in a portfolio of stocks and bonds that gradually become more conservative as your child nears college age. If the baby's grandparents or favorite aunts and uncles would like to save on your child's behalf, they too can make state tax-deductible contributions into a 529 plan.
Many parents consider saving for college and funding for their retirement an either/or proposition. But while it's important to safeguard for your child's future, saving for retirement should still remain your top financial priority. Note that if you don't have a lot to save, Roth IRAs might be your best bet. Since you can withdraw your contributions tax-free and penalty-free at any time, parents are able to multitask for both retirement and college savings in a single vehicle. (Given Roth IRA contribution limits, however, it will be difficult to save all you need for both college and retirement in this one vehicle.)
Don't Forget Basic Estate Planning
If you're a new parent, another key step is to designate a legal guardian for your child in case something should happen to you or your spouse prematurely. Also make sure that your guardian understands, and is comfortable with, the implications and responsibilities involved in being named your child's potential legal guardian. As you name your guardians, it's a good time to tackle the other key components of your estate plan, including drafting a will and living will.
Many assets such as IRAs, life insurance policies, and 401(k)s can be transferred to a beneficiary at death. But assigning minors as beneficiaries presents several potential pitfalls. For example, minors cannot legally own any assets. So if you want to name a child under 18 as your beneficiary, he would need a court-appointed guardian, which can be costly.
Take Advantage of Tax Benefits
Having children is a costly proposition: A 2009 United States Department of Agriculture report put the cost of raising a child until the age of maturity at roughly $222,000. However, it's possible to obtain some tax savings along the way.
Start by applying for your child's Social Security number right away for tax purposes.
All parents are eligible to claim each child under 19 as a dependent on their tax returns, which reduces taxable income by $3,950 in 2014. (The exemption also applies if your child is a full-time student under the age of 24.) Another potential tax break for parents is the $1,000 annual child tax credit, which applies to children under 17, provided your income falls below certain thresholds.
If you're paying for child care, your workplace might also provide ways for you to save on taxes. Through flexible spending accounts, parents can put away up to $5,000 in pretax dollars for child care (if their child is under the age of 13) through an employer-sponsored program. Click here for more information on the dependent-care FSA.
Parents may also qualify for the child-care tax credit as long as both spouses are working and your child is under 13. Unfortunately, you can't double up on the FSA and the tax credit.
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