Baby Talk
As a new parent, I’ve spent a lot of time thinking about how to prepare and provide for the newest addition to my family. A child is truly an extraordinary blessing that comes with new opportunities, new responsibilities, and no user manual. While I enjoy the present and each passing milestone, I also spend time considering his future. I’ve taken the same approach with our family’s financial plan to balance present needs and future security.
It’s a good thing kids are cute because they can do a number on even the most finely tuned budget. Based on the USDA’s most recent estimate, a new parent in 2022 can expect to spend roughly $315,000 to raise the child through age 17. This number includes basics like housing, childcare, food, and clothes. It does not include the cost of private, religious, or post-secondary education like college or trade school. According to the National Center for Education Statistics, four years of college at a private university can run $150,000. With inflation measured by the Consumer Price Index not projected to dip below 3% until well into 2023, all these costs will continue to increase.
As we are reminded more often than we’d like lately, the market and the economy are uncertain. Foresight and preparation can be the antidote. Here are some strategies to help parents sleep at night (even when your baby doesn’t).
Begin saving early and aggressively
Start saving before the child arrives. Understand the ongoing and future costs that you will be responsible for. There are often tradeoffs and important conversations to have early on. Ask yourself:
· Will one spouse stay home or work part-time, or will we need the services of a nanny or daycare?
· Do we need to save for private school? How about college?
· Are our cars safe enough?
· Do we need to find a new home?
· How much do we want to contribute to other celebrations like religious ceremonies and weddings?
Some of these expenses are so far in the future that it can be difficult to justify a line item in the budget today. With the increase in expenses, your personal savings plans may have ebbs and flows. Save aggressively what you can when you can. Eliminate high interest debt. Make sure you have a cash cushion to cover unexpected expenses, including those related to the birth. Get creative and have a positive attitude. I was more aggressive with retirement contributions in the years prior to our child arriving, expecting that more of my paycheck would be earmarked for childcare in the future. Set your goals and work backward to establish savings plans for each goal. It's a lot easier to stay on track when you know what you’re shooting for. Time is your biggest ally in growing your assets to meet your goals.
Take advantage of college savings plans
If you choose to contribute to your child’s college education, it will likely be the largest lump-sum expenditure you will make on their behalf. Utilize college savings plans as soon as you can and be aware asset ownership can affect the Free Application for Federal Student Aid (FAFSA) financial aid calculations. The most popular college savings vehicle is a Section 529 Plan, also known as a Qualified Tuition Program, which has no AGI (Adjusted Gross Income) limits on eligibility for contributions. Contribution limits per beneficiary will vary by state. There are two types of these plans - prepaid tuition plans and college savings plans, and every state offers at least one of the two.
· Prepaid tuition plans cover tuition and fees, must be used to attend a college in the state in which the plan was established to receive full benefits, and will generate inflation-based returns.
· 529 college savings plans are tax-advantaged savings vehicles in which earnings and withdrawals are tax-free when used to cover qualified education expenses. These expenses include the full amount of college tuition and fees, books, and room and board as long as the student is enrolled at least half-time, and up to $10,000 annually for almost any K-12 public, private, and religious school, regardless of location. College savings plans generate market-based returns and may be transferred among beneficiaries by the account owner.
Also consider custodial accounts such as those established under the Uniform Gift to Minors Act (UGMA) and Uniform Transfers to Minors Act (UTMA) to pass assets to the next generation. There are a few key differences when comparing these to the Qualified Tuition Programs. UGMA/UTMA accounts can only be assigned to one child and may not be transferred, are taxed as an estate/trust, and when the child reaches the age of majority in the state in which the account was established, the assets become immediately available to them to use however they see fit.
Explore opportunities for grandparents
Many of you are in the fortunate position to be watching your own children make these decisions. Even small gifts that are given time to grow can have a big impact. You can create or contribute to a college savings account or a minor custodial account. A Section 529 plan owned by a grandparent is not included in the family’s assets for the FAFSA calculation, but distributions are included as untaxed income for the student, so use precision in timing the distributions if possible. It is often beneficial to wait to spend the grandparent’s assets until the later years of college or transfer the plan into the parent’s name if the assets are needed in the first couple years. Crummey trusts and Health and Education Exclusion Trusts are lesser-known vehicles worth exploring and can be useful estate planning tools. Series EE and I bonds kept in the grandparent’s name can also be a tax efficient way of saving for a grandchild’s education.
Be cognizant of gift tax and generation-skipping transfer tax consequences. Contributions made to a qualified tuition program or custodial account are subject to gift tax when they exceed the annual exclusion for 2022 of $16,000 per beneficiary. You can also take advantage of “superfunding” rules that allow a one-time contribution to a qualified tuition plan of up to five times the annual exclusion limit, letting the full contribution begin to grow tax-free while spreading the annual exclusion over the next five years to avoid gift tax. If the child is older and long-term capital appreciation isn’t the primary goal, payments made directly to a qualified education institution are considered qualified transfers and not subject to gift tax.
It may seem like there are a lot of rules and restrictions around these savings accounts, but the benefits are worth taking advantage of. The best thing you can do is start saving early and often. Work with professionals to answer any questions you have and do your best to stay on track with your plan. As always, if you have any questions, reach out to us here at Provident and we’ll be happy to help.
Eric Pozolo, CFP®