Financial Planning for Parents with Young Children

Oftentimes an individual’s financial picture will change when they get married. You now have shared incomes, shared expenses, and shared financial goals. Bringing children into the picture is another life event that can have significant financial consequences, and drastically reorient financial goals. The pre-children era of simplicity in which the primary goals are often saving for retirement, saving for a home, or saving for a vehicle, do not go away; yet they may now be impacted or limited by the additional current expenses associated with caring for a child (childcare costs, furniture, health insurance, etc.).

You may now also have added future expenses associated with that child, such as a vehicle purchase, private school tuition, college tuition, etc. This article is an overview of some of the more common things to keep on the radar, and some common strategies to aid in the accomplishment of those goals.

Managing the Impact

As mentioned in the introduction to this article, having children brings on a whole new set of expenses, both current and future. Many of those expenses will hit immediately (i.e. childcare, medical expenses, diapers, furniture, formula, etc.); however, child-related expenses are an ever-evolving aspect of the budget.

•Emergency Fund: One of the potential best first steps is to ensure you have an adequate emergency fund in place (oftentimes 3-6 months of expenses), that is set aside from your investments and held in a money market fund or other highly liquid savings vehicle. As those immediate expenses begin to hit, the emergency fund enables you to cover them without more significant negative consequences (i.e. accumulating high interest credit card debt). In light of the unpredictability of costs associated with raising children (and just generally in the early-adulthood phase of life), it may be a good practice to continue saving into a non-retirement account even above-and-beyond the six months of expenses. Not only does this enable you to retain the principal of your emergency fund for a catastrophic event (i.e. job loss), but it also forces you to budget that savings in, such that if you are surprised by a new recurring expenses, you are able to divert those savings towards that new expense immediately. If on the other hand, you gradually establish some level of predictability in parenthood, you could pivot and move those monthly savings to another financial goal (i.e. college savings, retirement, down payment on a home, etc.).

•Retirement: In a perfect world, you would have had a stable job for a few years prior to having children. If that happens to be the case, ideally your employer offers some sort of qualified retirement plan which allows you to defer a portion of your income towards retirement. Excluding the added complexity of saving for retirement versus paying off high-interest credit card debt, most financial advisors would recommend starting your retirement savings as early as possible, saving (at a minimum) enough to qualify for the full employer match, and as soon as possible ratcheting that savings rate up to a minimum of 15% of your income. Sometimes this isn’t possible for an entry-level employee, but it may be possible for that person to start at a lower percentage, and each time they get a raise increase that deferral rate by a few percentage points until they are hitting the appropriate savings benchmark. If you are a few years aways from the point at which you plan to have children, it would likely be extremely beneficial to do everything you can to get that savings rate to at least 15% (or the appropriate benchmark for your specific circumstance) before having your first child. Doing this first, before children, allows your post-first-child financial life to grow in around your savings rate. Some lifestyle creep is natural when children enter the picture as you may need a larger vehicle, or a bigger house, but if you are already hitting your appropriate retirement savings benchmark, then any lifestyle creep will happen around that savings, instead of being a detriment to it. Preparing in advance can mitigate the risk of those new expenses negatively impacting your pre-existing financial goals.

•High Interest Credit Card Debt: As mentioned in the bullets above, one of the commonplace financial goals that competes with retirement savings is paying down high interest credit card debt. Oftentimes you will hear advisors say that you should first save enough for retirement to at least capture the employer match, and then divert additional savings to pay off high interest debt, before circling back to contribute more to retirement. There are different tactics as it relates to the approach of paying down debt (start with the highest interest accounts first and work down to the lowest or start with the card that has the smallest balance and work up to the one with the largest). The bottom line is that if you can get any credit cards paid off prior to your first child, then you will have increased optionality as it relates to managing new expenses and accomplishing new and existing financial goals as those milestones arrive.

Note: the IRS typically imposes penalties of 10% on distributions from a retirement plan (i.e. 401(k), IRA, etc.) prior to age 59 ½. There are some exceptions related to some of the topics in this article (i.e. up to $5,000 for the birth or adoption of a child, total and permanent disability or death, education (IRA only), $10,000 for a first-time home (IRA only), or personal emergency expenses. However, the goal should be to plan in advance (i.e. budgeting, emergency fund, etc.) to allow those dollars that are earmarked for retirement to remain invested in those accounts, and not interrupt the compounding that is occurring for your benefit later in life. (The above listed of exceptions is not comprehensive.)

Life and Disability Insurance

•Life Insurance: Whereas before children, if an emergency arose that resulted in death, it would be devastating, but it would (generally) only financially impact your spouse (excluding the possibility of other family members depending on you for financial support). Your spouse would likely have the ability to seek employment and support himself or herself (if not already employed). (Even with only a spouse, it is still oftentimes prudent to acquire the appropriate level of insurance coverage to cover funeral expenses, estate administration expenses, debt payments, and lost wages (to name a few). The addition of children brings in all of the aforementioned costs (to name a few) such as childcare, private school, vehicle purchases, college tuition, etc.; not to mention the more subtle but, over time, significant costs of daily essentials. This prompts a necessary assessment (or secondary assessment) of life insurance needs. There are some general rules of thumb that could be applied to determine how much life insurance you need (i.e. 5-10 times your income, leaning towards to the lower amount if you add the balance of outstanding debt or if you add a percentage or two per-dependent), and there are several companies who offer online calculators to help drill into this number more accurately; however, the best approach is to consult with a qualified insurance expert. There are also many different types of life insurance policies available. While term policies are often the least expensive and accomplish the goal of providing coverage, the complexity of the insurance world, again, is reason enough to consult with a qualified professional to help determine the insurance need and the policy type.

•Disability Insurance: Disability can create many of the same problems, plus some. If you become permanently disabled it may be the case that you can no longer contribute towards the family’s financial goals, and yet unlike the scenario of death, you remain in the picture as an expense to the family, highlighting the need for adequate disability insurance coverage. The first step in approaching disability is to check with your employer. Many employers not only offer this coverage, but also pay the premiums. You may be insured and not even know it! Generally the benefit payable is a percentage of your income. Sometimes this percentage would not be sufficient for your family to maintain their existing standard of living, which would imply the need for supplemental insurance above-and-beyond what is provided through the company. Additionally, some disability plans require a waiting period (elimination period) before the benefit payments begin. This elimination period can force a disabled individual to accumulate the wrong kinds of debt (i.e. credit card debt) while they wait for benefits to begin. This reiterates the importance of having an emergency fund (as mentioned above) to cover the family’s expenses during the elimination period. It is also important to review health insurance, auto insurance, and homeowners or renters’ insurance to be sure that those coverage levels are still appropriate. Additionally, umbrella insurance may be a good addition to the overall risk management approach to create higher coverage levels across the board (generally at a fairly reasonable cost).

College Savings

As previously mentioned, there are many different strategies involved in saving for college. This part of the conversation begins to steer away from current costs and current risks to future expenses. Saving for college (or higher education in general) can seem like a distant concern when there are pressing needs today; however, if done correctly, it could create a scenario in which you look up eighteen years from now and are grateful that you started saving, even if you started small. While there are several approaches to saving for college, this article will limit the scope on this topic to 529 College Savings Plans (contrasting periodically with the UTMA).

Some of the most common considerations when saving for college are: 1.) tax benefits, 2.) control, 3.) flexibility, and 4.) financial aid.

•Tax Benefits: Once contributions have been made to a 529 plan, all earnings grow tax-deferred (meaning the owner is not depleting the assets each year as they pay taxes on dividends, interest, and/or capital gains), and distributions from the 529 plan are tax-free, as long as they go towards educational expense. The implication here is that it is possible to increase the final after-tax savings in a 529 plan over a taxable account. Some other account types (including the Uniform Transfers to Minors Account (UTMA)) are not tax-sheltered.

•Control: The 529 allows the parent to retain control over the account assets, whereas a UTMA becomes property of the child at attainment of age eighteen or twenty-one, depending on the state.

•Flexibility: The obvious reason that one would save in a UTMA versus a 529 plan is to mitigate against the risk that the child does not need the funds for higher education (either does not choose to attend school or receives scholarships). This would create problems for money held in a 529, as it would be taxed and penalized if withdrawn for purposes other than education. The UTMA at this point in time, could continue to be used for the child’s benefit, regardless of whether that may be education, a down payment on a home, starting a business, etc. For this reason, some parents will overweight savings in their older child’s 529, so that if the older child doesn’t use a portion or any of it, they can roll the savings down to their next child (tax and penalty free) to be used for his or her education. If the older child does not attend school, there is flexibility. If the younger child does not attend school (or gets a full scholarship) and the parents have no other qualifying family members for whom they wish to cover the cost education, then there isn’t much you can do with those savings without paying taxes and a penalty. That being said, there have been recent legislation changes which allow a 529 owner to roll assets from a 529 plan (for whom their child is the beneficiary) into a Roth IRA for the child, giving the child a head-start on retirement. There are, however, many stipulations required by the IRS, one of which is that the 529 must have been opened for at least fifteen years. Additionally, no assets (or earnings on those asses) which were contributed in the last five years are eligible for a rollover, and the rollover Roth contributions are still limited to the annual IRA contribution limit ($7,000 in 2025). There is also a lifetime limit to what can be rolled over ($35,000).

•Financial Aid: When financial aid is being determined, assets of the parent and the child are taken into consideration. Both of these account types will count against how much financial aid a child can get for college; however, generally the 529 assets count for less, and utilization of a 529 plan results in more financial aid being approved than the UTMA. Interestingly, it seems that when the child’s grandparent(s) owns a 529 plan for their benefit, it doesn’t count against how much financial aid the child may be approved for.

There are many considerations which go into developing a college savings plan. There is no right or wrong approach, as long as you have a plan and stay consistent. Some parents choose to enjoy the control and tax benefits of the 529 plan, while others prefer the flexibility of the UTMA. Some employ use of both and allocate their savings between the two. Some utilize the 529 to provide for a reasonable estimate of college tuition costs but continue to save in their own taxable investment accounts with no goal in mind with the intention that they will make up any shortfalls from their own money. If money is distributed and paid directly to a qualifying institution of higher education, then gift taxes are generally not a concern. Consistency and endurance are of paramount importance in any financial endeavor. There will always be a higher likelihood of success when savings rates are consistent, and when the investor sticks to the investment strategy, taking advantage of all the available years of compounding. Always remember to view your college savings goals within the context of your other financial goals, namely, retirement. A qualified financial advisor should be able to advise as to whether your college goals are realistic in relation to your retirement plan, or conversely, whether your college savings goals represent a potential detriment to your retirement goals. Such an advisor can also aid in managing the investment strategy within the account types as the beneficiary approaches and moves through their higher education program.

Estate Planning

As discussed above, these strategies are important to implement even prior to children; however, they become that much more pressing when children are brought into the picture. Meeting with a qualified estate planning attorney may entail a modest cost, but it will ensure that your financial affairs are handled appropriately (and according to your wishes) in the event of death or incapacity.

Some common documents to inquire about are listed below:

•Last Will & Testament: Creating a will can ensure that your assets are distributed according to your wishes. It enables you to select who you would like to be the executor of your estate, giving you the option to name a trusted family member, or a corporate executor if you wish to relieve your family of that burden and ensure competency in the administration process. Also within this document, you can name who you wish to be the guardian(s) of your children if both spouses pass away.

•Medical and Durable Powers of Attorney: These documents mitigate the risk of adverse financial or medical consequences arising in the event of your incapacity. It may be prudent to get these documents on file with your providers and advisors in advance of incapacity to ensure the documents are styled according to the respective firms’ requirements.

•Medical Directive: The medical directive indicates to your family your preferences as it relates to life-sustaining medical support in a terminal circumstance. If your preference in such a situation is not to be kept alive, having this document in place can ensure that your family is aware of your wishes, and can mitigate the risk of higher end-of-life expenses, which could reduce the amount of your residual estate which would otherwise have been distributed to your spouse or children.

•Testamentary Trusts: Within the Last Will & Testament, you can ask your attorney about implementing provisions to establish a testamentary trust (or multiple trusts) to provide for a spouse or children after your death. If both spouses pass away, your will could dictate that all proceeds from the estate (less specific bequests, administrative costs, taxes, debts, etc.) be funneled into testamentary trusts for your children The provisions of these trusts can be catered to your specific needs, allowing you to name a trusted family member or a corporate trustee to manage the assets on behalf of your children until they reach an age in which it would be appropriate to distribute the remaining assets for them outright. It may be the case that you name a family member as the guardian of your children and name a different family member or corporation as trustee of the trust(s) in the event that you want to ensure a higher degree of expertise in asset management and trust administration.

•Revocable and Irrevocable Trusts: You can create trusts during life (as opposed to trusts written within the will), which can aid in providing for incapacity (revocable), avoiding probate (revocable), reducing the possibility of will contests (revocable), or reducing the size of your estate for estate-tax purposes (irrevocable). An irrevocable trust can be setup during life to which gifts can be made, which while such gifts would reduce the lifetime exemption amount (over $13 million in 2025), any future appreciation on the assets gifted is generally excluded from the decedent’s estate for estate tax purposes. Most trusts (testamentary, revocable, and irrevocable) allow some level of control over those assets after death, which can also be a benefit to the decedent.

Finally, as you move through your financial lives with your children, be proactive as it relates to not only teaching them about prudent financial management, but also, where appropriate, sharing with them some of the relevant details about your financial plans to better position them in the event of an eventual inheritance. Always consult with qualified attorneys, accountants, insurance experts, and financial advisors before making financial, insurance, or estate planning decisions.

Conclusion

Finally, as you move through your financial lives with your children, be proactive as it relates to not only teaching them about prudent financial management, but also, where appropriate, sharing with them some of the relevant details about your financial plans to better position them in the event of an eventual inheritance. Always consult with qualified attorneys, accountants, insurance experts, and financial advisors before making financial, insurance, or estate planning decisions.

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