Planning for Baby - Family Finances

Authors: Celia Ray Hayhoe, Ph.D., CFP®, Family Financial Management specialist; Stephanie Jamison and Anne Fleet Dillard, graduate students, Department of Apparel, Housing, and Resource Management, and Melissa Chase, doctoral candidate, Technical Education, Virginia Tech.

The authors would like to thank the following reviewers for their comments:
Robert Flashman, Ph.D., and Susan Badenhop, Ph.D., Cooperative Extension specialists, University of Kentucky, and Heather Greenwood and Lou Gorr, Virginia Cooperative Extension Family and Consumer Sciences and Community Initiatives agents in Fauquier County and Prince George County respectively.

Publication Number 354-030, May 2003

Table of Contents

Introduction Tax Benefits for Raising a Child The Cost of Raising a Child Child Care Making a Spending Plan Health Insurance for Your Child Food Program for Women, Infants, and Children (WIC) Saving for College Resources on Raising a Child Table 5. Estimated 2001 Annual Expenditures Overall United States

* See PDF file at bottom for Appendix A and B forms.

Introduction

This publication is designed to help your family understand the obvious and hidden costs of raising a child. According to the USDA, there are many things to consider, including housing, food, transportation, clothing, health insurance, child care, education, and miscellaneous goods and services. This publication focuses on these categories with exercises to help you become more prudent in making the financial decisions for your household.

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Tax Benefits for Raising a Child

Personal Exemption
Regardless of when your child is born during the year, you will receive an additional personal exemption at tax time. In 2003, each personal exemption will reduce your taxable income by $3,050. For parents to claim the exemption, the child must have a Social Security number, so apply for one as soon as your child is born. You can apply at any Social Security office or you can download the form to apply for a number at the Social Security Administration web site, http://www.ssa.gov.

Tax Credits
Having a child may qualify you for certain tax credits. Tax credits are more advantageous than deductions. A tax deduction such as medical expenses only helps if you have enough deductions to itemize. If you itemize, a deduction reduces your income. Therefore, you only save the amount of your tax bracket. For example, if you are in the 15 percent tax bracket, then $1.00 of deductions saves you $0.15 in income taxes. A tax credit of $1.00 saves you $1.00 in income taxes. See IRS Publication 17 for more on the difference between a tax credit and a deduction.

Taxpayers who owe taxes benefit most from tax credits since most tax credits can only be used to reduce the amount of income tax that you owe. Except for the Child Tax Credit and the Earned Income Credit, you will not benefit from a tax credit unless you owe taxes. However, under certain circumstances, you will receive payments from the Child Tax Credit and the Earned Income Credit even if you do not need them to reduce the amount of federal income tax you owe. Tax credits are subtracted from the tax owed. If the credits are large enough, they could reduce the amount of tax due to less than you had deducted from your pay through federal withholding. When the amount you already paid through federal withholding is more than the total income tax you owe, you receive a refund.

Child Tax Credit
The 2003 Child Tax Credit is $600 per child. If your tax form shows you owe federal income taxes, the amount you owe is reduced by the credit. However, you may be able to receive this credit in the form of a refund even if you do not owe any tax or did not use the full amount of the credit when figuring your tax. Use Form 8812 to see if you are due a refund. If you are self-employed, the refund will be used to reduce any Social Security or Medicare taxes that you owe because you are self-employed. The overpayment created by the Child Tax Credit will be sent to you as a refund along with any refund due you for overpayment on withholding for the federal income tax. For more information, see IRS Publication 972, which includes the required worksheets to determine if you are entitled to the credit.

Earned Income Credit
The second tax credit that allows a refund is the Earned Income Credit (EIC). There are new rules for determining eligibility for this credit. So even if you have not qualified before, it is worth checking again. In 2003, income limit for single taxpayers with one qualifying child is $29,666 ($30,666 for married filing jointly), $33,692 ($34,692 if married filing jointly) with more than one qualifying child, or $11,230 ($12,230 if married filing jointly) with no qualifying child (IRS Bulletin 2002-46, Revenue Procedure 2002-70, Nov. 18, 2002). For clarification on qualifying income and children see IRS Publication 596. You need to file IRS Form EIC with your tax return to claim this tax credit. If you expect to be eligible for this credit in 2003, complete a W-5 Form at work to receive advance payments in each month's paycheck. You must file a new W-5 Form with your employer each year to receive advance payments.

Dependent Care Credit
If you (and/or your spouse) work, are looking for work, or go to school and you pay someone to care for dependents (a child or elderly parent claimed as a dependent on your federal income return), you may be entitled to a Dependent Care Credit in addition to the Child Tax Credit. This is not a refundable credit; however, using this credit may reduce the amount of tax you owe and increase the refund created by the Earned Income Credit and Child Tax Credit. To claim this credit, you, the taxpayer, must pay someone who you do not claim as a dependent, a nondependent, to provide the care. This caregiver must provide you with a taxpayer ID number or a Social Security number. If you use pre-tax dollars from you employer-sponsored Dependent Care Flexible Spending Account to pay these expenses, you cannot use the pre-tax dollars you paid to figure the credit. The amount of any Dependent Care Credit is figured as a percentage of the amount you paid for dependent care and that percentage is based on your income. To claim this credit, you must file an IRS Form 244. For more information see IRS Publication 503.

Flexible Spending Accounts
Employer-sponsored Flexible Spending Accounts allow you to pay for dependent care and medical costs with pre-tax dollars. The amount you contribute to your account is deducted from your annual earnings before they are reported on your W-2 Form at the end of the year‹your taxable income is reduced by the amount you contributed to the Flexible Spending Accounts. Your total annual contribution is divided by the number of paychecks you receive and is deducted evenly from each paycheck. You pay the bills out of your pocket and then submit the bills according to your employer's instructions for reimbursement. Most employers allow you to submit bills up to the maximum annual contribution even if the full amount has not yet been deducted from your pay or deposited in the Flexible Spending Account. The maximum amount that can go into these accounts is $5,000 per employee, but your employer may set a lower limit. The drawback to Flexible Spending Accounts is that any money left in the account at the end of the year will go to your employer not to you.

As with the Dependent Care Credit, the taxpayer must have a Social Security number or Tax ID number from the caregiver in order to submit bills for reimbursement. To determine whether the Flexible Spending Account or the Dependent Care Credit is best for you, consult a tax professional.

The Medical Flexible Spending (MFS) Account is structured similar to the Dependent Care Flexible Spending Account. Doctor visits and medications are likely to increase with the birth of a baby, so an MFS Account is an option to cover co-payments and other medical expenses not reimbursed by health insurance. Since most people cannot deduct these expenses at tax time, the MFS Account allows you to pay these expenses with pre-tax dollars.

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The Cost of Raising a Child

There are seven main categories on which the USDA bases its calculations for raising a child: housing, food, transportation, clothing, health care, childcare, education, and miscellaneous goods and services. See Table 5, Estimated 2001 Annual Expenditures, on page 9.

Housing: The government estimates the average middle-class family with one child will spend an extra $53,310 on shelter until the child is 18. The average annual cost for one child ranges from $2,000 to $5,370.

Food: The items include food and nonalcoholic beverages purchased at grocery, convenience, or specialty stores, including purchases with food stamps, dining at restaurants, and household expenditures on school meals. The average annual cost ranges from $910 to $2,530.

Transportation: This includes the purchase of new or used vehicles, vehicle finance charges, gas, car maintenance, repairs, insurance, and public transportation. The average annual cost ranges from $750 to $2,330.

Clothing: Clothing a child for 18 years costs an average of $10,470. The average annual cost ranges from $360 to $1,100.

Health Care: Many health care companies have family plans with a set monthly premium that covers an entire family, up to a certain amount. The average annual cost ranges from $440 to $1,000. Check into your health provider's plans and make sure you have health insurance for your children before they are born! Some plans do not pay until after the child is 6 months old.

Table 1. The average cost of preparing for a baby

Crib, mattress, dresser, rocker	$1,500
Bedding/Decor	$ 300
Baby Clothes	$ 500
Disposable Diapers	$ 600
Maternity/Nursing Clothes	$1,200
Nursery items, high chair, toys	$ 400
Baby Food/Formula	$ 900
Stroller, Car Seat, Carrier	$ 300
Miscellaneous	$ 500
Total	$ 6,200

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Child Care

The Children's Defense Fund said the average weekly costs of child-care centers in major cities and their surrounding suburbs as of December 2000 was:

• New York: $174 per infant; $155 per toddler
• Atlanta: $116 per infant; $96 per toddler

The average costs in rural areas were:

• Somerset County, Maine: $90 per infant; $75 per toddler
• Lee County, South Carolina: $65 per infant; $65 per toddler

Table 2. Weekly Child-care Rates in Two Virginia Counties

Child Care Rates in Fairfax County, June 2002
	Family-Run Center	Public Centers
Infant	$125 - $225	$165 - $225
Toddler	$125 - $200	$165 - $210
Preschool	$100 - $155	$110 - $175
K-12 (full time)	$80 - $150	$100 - $150
Before and After School	$60 - $80	$60 - $80

Source: the Fairfax County web page http://www.fairfax.va.us/service/ofc/Avcostcare.htm

Market Rates for Child Care in Prince William County
	Family-Run Center	Public Centers
Infant	$134 - $145	$154 - $187
Toddler	$128 - $130	$146 - $178
Preschool	$113 - $123	$121 - $128
K-12 (full time)	$98 - $123	$ 96 - $121
Before and After School	$68 - $97	$70 - $88

Source: Virginia Department of Social Services

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Making a Spending Plan

A spending plan is always an effective tool to help you get the most for your money. It is especially important when you have a sudden change in your income or your expenses. A spending plan helps you:

• make decisions about how to spend your money
• match your spending to your current income

The following information can help you set up a spending plan (a budget) for your current income and the changes in your expenses due to the new baby. Start with a monthly plan. This plan will list every item you spend money on during the month. Then expand your plan to 12 months and be careful to include occasional expenses such as taxes, auto license, gifts, holiday meals, and vacations. The easiest way to do this is to use a calendar and mark when these expenses are due. Then total the amounts by category over the year and divide by 12 to get the amount needed in the monthly budget. For example, if you spend $20 for gifts in February, $50 in May, $20 in June, $75 in July, and $300 in December, the total for the year is $445. Divided by 12 that equals $37 a month you should put in your spending plan for gifts. Some months you will spend nothing on gifts and other months you will spend more than your spending plan shows, but over the year, the amount should balance out.

(See How to Make Your Money Go Further, Virginia Cooperative Extension publication 354-028, for more details on setting up a spending plan and covering the additional expenses. You can find the publication on-line at http://www.ext.vt.edu/pubs/family/354-028/354-028.html or through your local Extension office.)

Making a Spending Plan Work
Once you have a spending plan that sets amounts for essential family needs and balances your spending with your income, you need to follow it. Writing it down is not enough, the plan must be used to guide your spending.

Keep track of your spending to be sure you don't exceed your spending plan amounts. The best way to do this is to keep a record of your spending in each expense category. There are several ways to do this. One way is to use an accordion file with a slot labeled for each of the expense categories. Place all receipts into the correct category. In each category slot, place a piece of paper with the total amount you budgeted for that category. Each time you put a receipt into the folder, deduct that amount from the total amount budgeted. With this method you will be able to see the amount of money left in each category each time you spend money.

Another way to set up a monthly plan is to use a computer program that allows you to enter each check, note what it is for, and then compile monthly reports. When using this method, you must also keep a cash log for items paid for with cash. A cash log is a small notebook you carry with you. You enter each cash purchase when it is made. Include snacks, fast food, newspapers, what you buy from vending machines, and anything else paid for with cash. Record the date, amount and the spending category where the expense belongs. Once a week, total the amounts spent in each category and enter them into the computer program. If this is the first time you have made a spending plan, keeping a cash log for a month will give you better estimates for your categories.

A third way to set up your monthly plan is to use an account book or columnar paper to keep track of expenses. It is best if you enter amounts daily so you do not forget any items.

Regardless of which method you use, once a month compare the actual amount you spent to the amount you budgeted. If you find a forgotten expense or income, make the adjustments immediately. Some differences, especially for variable expenses, will work out over the course of a year. Once your monthly budget is working, complete a plan for the year. A computer program will let you enter your spending plan amounts and print a report of your actual versus your planned amounts.

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Health Insurance for Your Child

If your household income is between 134 percent and 200 percent of the federal poverty guidelines and your child does not have access to health insurance, he or she may qualify for coverage under Family Access to Medical Insurance Security. FAMIS covers doctor's visits, well-baby checkups, hospital visits, vaccinations, prescription medication, tests, x-rays, dental care, emergency care, and vision care for children 18 years old and under who live in Virginia. Co-payments may apply for some services. You can contact FAMIS toll free at (866) 873-2647 or at http://www.famis.org. Information is also available through your local Department of Social Services.

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Food Program for Women, Infants, and Children (WIC)

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Saving for College

Colleges and professional schools are expensive and being able to pay may allow your child to consider more schools and institutions.

Some of the plans mentioned below also allow you to pay for primary and secondary school expenses. The earlier you start, the more compound interest can work for you to increase your savings.

There are many ways to save for college. You can use regular investments and savings accounts, but the earnings will be taxed every year at your tax rate. You can use Uniform Gift to Minor Accounts (UGMA). These can be used with any type of investment or savings account. They are held in the child's name with you as custodian until the child reaches legal age, which is 18 in most states. These accounts will be taxed at your rate until the child is 14 and then they will be taxed at the child's rate. The advantage is that the funds can be used for the benefit of the child at any time and not just for school expenses. The disadvantage of these accounts is that the money goes to the child at age 18 whether he or she goes to college or not.

There are several ways to save tax free for college: U.S. savings bonds, Qualified State Tuition Programs (QSTPs), and Coverdell Education Savings Accounts (ESAs) (formerly known as Educational Individual Retirement Accounts). You cannot contribute to a Coverdell ESA and a QSTP in the same year. In addition, starting in 2003, some of these plans can be used to pay for certain elementary and secondary school expenses. For more detailed information see IRS Publication 970.

U.S. Savings Bonds
A qualified U.S. Savings Bond is a Series EE bond issued after 1989 or a Series I Bond. The bond must be issued in one or both parents' names and the owner must be at least 24 years old when the bond is issued. The issue date is printed directly on the front of the savings bond. Since the bonds are in a parent's name, they can be used for a child or the parents. Qualified U.S. Savings Bonds can be used for other purposes; you will just have to pay tax on the interest. They are also easy to purchase through a payroll savings plan with most larger employers, at any bank, or directly from the Federal Reserve.

Parents may be able to cash qualified U.S. Savings Bonds without having to include the interest in their income if they meet the following conditions in the year they cash the bonds.

• They pay qualified higher-education expenses for themselves, their spouse, or a dependent for whom they claim an exemption on their return.
• Their modified adjusted gross income meets certain limits.
• Their filing status is not married filing separate returns.

Qualified higher education expenses. These include the following items you pay for either yourself, your spouse, or a dependent for whom you claim an exemption.

• Tuition and fees required to enroll in or attend any college, university, vocational school, or other postsecondary educational institution eligible to participate in a student aid program administered by the Department of Education (Qualified expenses do not include expenses for room and board or for courses involving sports, games, or hobbies that are not part of a degree program.)
• Contributions to a qualified state tuition program
• Contributions to a Coverdell ESA

Expenses reduced by certain benefits. You must reduce your qualified higher education expenses by the amount of any of the following benefits received by the student.

• Tax-free scholarships
• Tax-free withdrawals from a Coverdell ESA
• Any nontaxable payments (other than gifts, bequests, or inheritances) received for education expenses or for attending an eligible educational institution, such as:
• Veterans' educational assistance benefits
• Benefits under a qualified state tuition program
• Tax-free, employer-provided educational assistance
• Any expenses used in figuring the Hope Scholarship Credit and Lifetime Learning Credit

Qualified State Tuition Plans (§529 plans)
Under current law, a qualified state tuition program (QSTP) means a program established and maintained by a state under which a person may: (1) prepay tuition benefits on behalf of a beneficiary so that the beneficiary is entitled to a waiver or a payment of qualified higher-education expenses, or (2) contribute to an account that is established for paying qualified higher-education expenses of the beneficiary. The tax on earnings attributable to prepayments or contributions is deferred until the earnings are distributed from the QSTP. The beneficiary pays tax on the earnings at the time of distribution. If amounts saved through a QSTP are used to pay for college, the student or the student's parents still may be eligible to claim either the Hope Scholarship Credit or the Lifetime Learning Credit. The following web site gives comparisons of these plans for Virginia residents along with a comparison of these plans and some of the other methods mentioned in this section: http://www.vpep.state.va.us/Comparison%20Insert.pdf.

Depending on the plan, the QSTP may cover some or all of the following expenses: tuition, fees, room and board, textbooks, and computers. It may guarantee to cover all tuition (referred to as a lock-in price) or only as much as is saved. To receive guaranteed, fully-paid tuition (also known as a lock), the child usually needs to attend a school in the state that is offering the plan. A caution when looking for an appropriate plan is to find one that is mobile and will cover any school the child attends. An advantage of these plans is that they cannot be touched by your creditors if you have financial difficulties in the future.

Coverdell ESA (formerly known as an Education IRA)
A Coverdell Educational Savings Account is a trust or custodial account. It is created or organized in the United States for the exclusive purpose of paying the qualified higher-education expenses of the account's designated beneficiary. For tax purposes, the Coverdell ESA must be designated as such when it is created. Coverdells are available through any bank, or other entity approved to serve as a nonbank trustee or custodian of an individual retirement account (IRA), if the bank or entity is offering Coverdell ESAs.

Coverdell ESAs are permitted to accept contributions made in cash only. Parents, grandparents, other family members, friends, and a child him- or herself may contribute a total of $2,000 per year into a Coverdell ESA. The child must be under age 18 unless he or she has special needs as defined by the Internal Revenue Service. However, there are income limitations (similar to the limits for Roth IRAs) for the contributors. See IRS Publication 970 for the current limits. Amounts deposited in the account grow tax-free until they are distributed, and the child will not owe tax on any withdrawal from the account if the child's qualified higher-education expenses at an eligible educational institution for the year equal or exceed the amount of the withdrawal. If the child does not need the money for postsecondary education, the account balance can be rolled over to the Coverdell ESA of certain family members who can use it for their higher education. Like a Roth IRA, these contributions are not tax-deductible. You may contribute to a Coverdell IRA even if contributions are being made to a Qualified State Tuition Plan (529) for the same child.

Amounts withdrawn from a Coverdell ESA that exceed the child's qualified higher education expenses in a taxable year are generally subject to income tax and to an additional tax of 10 percent. You may be able to use the Hope Scholarship Credit, Lifetime Learning Credit, or a withdrawal from a Qualified State Tuition Plan in addition to the tax-free withdrawal from a Coverdell ESA, but not for the same expenses. Whether the designated beneficiary is enrolled full-time, half-time, or less than half-time, he or she may take a tax-free withdrawal to pay qualified higher-education expenses.

"Qualified higher-education expenses" means expenses for tuition, fees, books, supplies, and equipment necessary for the designated beneficiary to enroll in or attend an eligible educational institution. Qualified higher-education expenses also include amounts contributed to a Qualified State Tuition Plan. Qualified higher-education expenses also include room and board (generally the school's posted room and board charge, or $2,500 per year for students living off-campus and not at home) if the designated beneficiary is at least a half-time student at an eligible educational institution. The standards for determining whether a student is enrolled at least half-time are the same as those used for the Hope Scholarship Credit.

An eligible educational institution is any college, university, vocational school, or other postsecondary educational institution that is described in section 481 of the Higher Education Act of 1965 (20 U.S.C. 1088) and, therefore, eligible to participate in the student aid programs administered by the Department of Education. This category includes virtually all accredited public, nonprofit, and proprietary postsecondary institutions. (The same eligibility requirements for institutions apply for the Hope Scholarship Credit, the Lifetime Learning Credit, and early withdrawals from IRAs for qualified higher-education expenses.)

In addition, you may withdraw funds to pay for tuition, fees, books, academic tutoring, room and board, uniforms, transportation, and a computer for any private, public, or religious kindergarten-through-twelfth-grade school.

What happens if there is money left in the account?
There are two options. The amount remaining in the account may be withdrawn for the designated beneficiary. The designated beneficiary will be subject to both income tax and the additional 10 percent tax on the portion of the amount withdrawn that represents earnings if the designated beneficiary does not have any qualified higher-education expenses in the same taxable year that he or she makes the withdrawal.

Alternatively, if the amount in the designated beneficiary's Coverdell ESA is withdrawn and rolled over to another Coverdell ESA for the benefit of a member of the designated beneficiary's family, the amount rolled over will not be taxed. Any amount distributed from a Coverdell ESA and rolled over to another Coverdell ESA for the benefit of the same designated beneficiary or certain members of the designated beneficiary's family is not taxed. An amount is rolled over if it is paid to another Coverdell ESA on a date within 60 days after the date of the distribution. Members of the designated beneficiary's family include the designated beneficiary's children and their descendants, stepchildren and their descendants, siblings and their children, parents and grandparents, stepparents, and spouses of all the foregoing. For example, an older brother who has $2,000 left in his Coverdell ESA after he graduates from college can roll over the full $2,000 balance to a Coverdell ESA for his younger sister who is still in high school without paying any tax on the transfer.

Table 3. Average Tuition and Fees for the 2001-2002 Academic Year.

	Tuition and Fees	Room and Board
4-Year Public College or University	$3,586	$4,956
4-Year Private College or University	$14,456	$5,704
2-Year Public College	$1,807	$4,837
2-Year Private College	$8,590	N/A

Source: College Board, 2001.

Table 4. Average Costs of Some Virginia Universities and Colleges for the 2002-2003 Academic Year.

Virginia Tech	In-state Tuition	$3,044
4-year public university	Annual Fees	$892
(based on 12 or more credit hours/semester for 2 semesters)	Average Room and Board	$4,132
	Total Cost	$8,086
University of Virginia	In-state Tuition	$3,321
4-year public university	Annual Fees	$1,274
(based on 12 or more credit hours/semester for 2 semesters)	Average Room and Board	$5,231
	Total Cost	$9,826
Roanoke College	Tuition	$19,716
4-year private college	Annual Fees	$650
(based on 12 or more credit hours/semester for 2 semesters)	Average Room and Board	$6,338
	Total Cost	$26,704
Virginia Western Community College	In-state Tuition	$1,200
2-year public college	Annual Fees	$104
(based on 15 credit hours/semester for 2 semesters)	Average Room and Board	N/A
	Total Cost	$1,304

Source: Show Me the Money! insert in The Roanoke Times January 19, 2003

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Resources on Raising a Child

msn-CNBC Money web site on college information: scholarship search, college search, resources, decision centers, articles, tuition savings calculator, etc., http://moneycentral.msn.com/articles/family/basics/6933.asp

msn-CNBC Money web site on "The Cost of Raising Children," http://www.moneycentral.msn.com/articles/family/kids/tlkidscost.asp

Cost of Raising a Child Calculators
http://www.americanbaby.com/ab/CDA/financialCalculatorMain/1,1356,BUD7,00.html?s=117

http://www.bankrate.com/ndaq/calc/helpraisechild.asp

http://www.bankrate.com/ndaq/calc/raiseChild.asp?nav=budget&page=calc_home

http://www.economicshomework.com/calculators1.htm

Additional Resources if You Need Financial Assistance

• The Department of Social Services: http://www.dss.state.va.us/ (Change abbreviation depending on your state)
• The Salvation Army: http://www.salvationarmyusa.org/www_usn.nsf
• The Red Cross: http://www.redcross.org
• Contact local churches for food banks etc.
• Contact hospitals in your area
• The Food Bank of the Virginia Peninsula: http://www.charityadvantage.com/foodbank/Home.asp
• The Food Bank of Southeastern Virginia: http://www.foodbankseva.org
• South Western Virginia Second Harvest Food Bank: http://www.swvasecondharvest.org/
• Food Bank Locations in Virginia: http://www.secondharvest.org/foodbanks/state_search_va.html

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Table 5. Estimated 2001 Annual Expenditures Overall United States

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