Steps to Take for Your Family’s Financial Well-being

There are numerous action steps you can take to help set your children for a successful financial future. The average cost of raising a child today from infancy to age 17, excluding college and higher education expenses, is approximately $275,000 based on inflation adjusted U.S. Department of Agriculture estimates.

Education Costs

Education costs are one of the highest expenses you will face as a parent or your child will incur in the form of debt upon graduating college. Published in-state tuition and fees at public four-year universities averaged $10,740 during the 2021-22 school year, compared with $38,070 at four-year, private nonprofit universities. The average cost of college tuition & fees at public 4-year institutions has risen approximately 180% over the last 20 years for an average annual increase of about 9%.

By electing to save for your child’s education in a tax-advantaged 529 investment account, you can prepare children for college or graduate school tuition. This account allows your money to compound over time (if appropriately invested), and you don’t have to pay taxes on the earnings if the money is used for qualifying education expenses. More than 30 states provide some measure of a tax deduction for 529 account contributions. If you’re fortunate enough to live in one of those states, then you can also reduce your state tax bill. Grandparents can also contribute to a 529 plan.

Custodial Accounts

There are two types of custodial accounts that are most commonly referred to as the Uniform Transfers to Minors Act (UTMA) and the Uniform Gifts to Minors Act (UGMA).  These accounts can allow parents and/or grandparents to start investing for a child today. A UTMA or UGMA account is similar to a brokerage or taxable investment account for minor children. Since children are not eligible to directly own property, UTMA accounts allow parents and grandparents to invest for a child’s future while they are young. You have access to a very wide range of investment options (unlike 529 plans which may have limited options). Your state of residence will determine the age your child will be able to access the funds, however the age of majority for most states is generally 18 or 21 years old. State law can vary with respect to these accounts and some states have tax benefits for you contributing to a child or minor’s 529 account.

Both of these are similar in goal; however, the UTMA can hold a variety of different asset classes such as real estate and artwork. The UGMA account is limited to financial assets such as cash, securities, bonds, mutual funds. These accounts are a good, flexible option for those parents who want their children’s money to grow but don’t want to restrict the funds specifically to education-related expenses.

One common concern from parents regarding UTMA or UGMA account is the age at which their children will be able to access the funds. With respect to UTMA accounts, capital gains, dividends, and interest accrued in them are taxable to the child’s parents regardless of who owns the account. However, these accounts are tax-free or taxed at a low “kiddie” rate for the first $2,300 of earnings in 2022.

Custodial Roth IRA

A custodial Roth IRA is another type of investment account that should be considered depending on circumstances.  This account is just like a regular Roth IRA, but is intended for a minor child earning income. It is subject to the same contribution limits as regular Roth IRA ($6,000 in 2022) and income limits (2022 modified adjusted gross income of under $144,000 for single filers or $214,000 Married Filing Joint filers). Your child needs to have earned at least the amount you contribute from a W2 or 1099 job in the year you make the contributions.

A custodial Roth IRA account might be for you if you have an older child who is already earning an income, or you have already set up a 529 or UTMA account for your child’s benefit. One advantage of this account is that the funds are contributed after-tax and can grow tax-free for decades.  As a retirement account, one drawback of this account is that you will be investing in highly long-term focused accounts for young children and they may not be able to access the money before retirement age without incurring a penalty.

Self-employed Parents

If you are the owner of an LLC or a business, one strategy you can pursue is to pay your child up to $12,500 for work done as an employee without them being taxed for the year and receive a deduction for it as an employer.  You should consult your accountant or tax advisor with respect to qualifications and your circumstances.

Child and Dependent Care Credit

The child and dependent care credit is a tax credit that may help you pay for the care of eligible children (and other dependents) for qualifying expenses. The credit is calculated based on your income and a percentage of expenses that you incur for the care of qualifying persons to enable you to go to work, look for work, or attend school. For tax year 2022, the amount of eligible dependent care expenses is $3,000 for one eligible person and $6,000 for two or more eligible persons. The credit is not refundable and the maximum credit rate is 35%.  The exclusion for employer-provided dependent care assistance is $5,000 ($2,500 for married filing separately).

Flexible Spending Accounts

A flexible spending account (FSA) is another option to think about that can be used to help take care of your dependents. This is an employer-sponsored program that allows you to set aside up to $5,000 per year tax-free, in 2022, for qualified childcare expenses for couples filing jointly with one or more dependents. You typically enroll in or renew your election in your Dependent Care FSA through your employer during your open enrollment period each year, but certain changes in status of “qualifying events” during the year -like having a baby -allow you to make changes. Your human resources department or benefits administrator can tell you when employees in your organization can enroll in a Dependent Care FSA.

You can use the dependent care FSA to pay for eligible Pre-K childcare expenses tax-free including nursery school, pre-school, or similar programs below the level of kindergarten. Expenses to attend kindergarten or a higher grade aren’t eligible FSA expenses, but childcare, expenses for before- or after-school care of a child in kindergarten or a higher grade up to age 13 are eligible. The care provider just can’t be your spouse or another dependent child.

Generally speaking, high-income families will benefit more from an FSA than from the Child and Dependent Care Credit (you can’t receive the full benefit from both). However, if you have two or more kids under 13 and spend $6,000 or more on child care, you may be able to partially benefit from both.  A potential drawback is that the IRS requires money contributed to a FSA to be spent during the plan year. If the money isn’t used, it’s forfeited. A tax professional can help determine what’s best for your situation.

Health Savings Accounts

One additional area of opportunity to further explore relates to establishing a Health Savings Account (HSA). You will need a qualifying high-deductible health plan to be used in conjunction with this type of account. You can check with your human resources/ benefits department to see if you qualify and learn about the process to establish the account. Health Savings Accounts differ from Flex Spending Accounts because they offer a triple-tax benefit. Contributions you make to your HSA are tax-deductible, so they should lower your income tax bill each year. You can withdraw money from your HSA tax-free if you use the money to pay for qualified medical expenses. An HSA account is also not taxed on the investment earnings, including dividends. In other words, you save taxes three different times with an HSA. (To compare and contrast, while you can make tax-free contributions to 401(k) plans, you pay ordinary income tax rates on withdrawals). When you retire, you can withdraw money from your HSA to pay for qualified medical expenses (including LTC expenses). These withdrawals are tax-free. That means you don’t have to make a taxable withdrawal from your IRA or 401(k).

You can fund an HSA until the last day of the calendar year. To get the optimal benefits from a Health Savings Account, you should invest the money for the future. If possible, you want to refrain from using it in the same year as you contribute money to the account. You cannot contribute to an HSA once you are enrolled in Medicare. You will need to stop contributing to your HSA account one month before your 65th birthday.

Estate Planning

Planning for the care of children in case of unfortunate circumstances is one of the most important things parents can do.  Estate planning could mean the difference between stability and chaos for bereaved children. The sooner a permanent or temporary guardian is appointed in these situations, the more quickly the child can adjust. Wills and trusts are important because they help inform your family how you want your assets distributed when you die. An essential part of a will, if you have minor children or children with special needs (regardless of age), is to appoint a guardian. The guardian will be the person appointed to take care of your children after you pass away until they reach the age of majority, which is 18 or 21 depending upon the state they live in. The guardian will be responsible for caring for your children; in essence, they will act as your child’s parent. If you do not appoint a guardian, the court will appoint one for you, who may or may not be to your liking.

Each U.S. state has its own guardianship requirements. A family lawyer can help you navigate the process in your state. No matter what, don’t assume whom guardianship of your child would go to after your death. Guardianship would only be necessary if your child’s other parent is also no longer alive or unable to care for your child sufficiently. In many states, courts have final say on who becomes a guardian. They base the decision on what’s best for the child and may let older children weigh in. In these cases, your role as a parent is to tell the court your wishes and any relevant facts ahead of time.

Special Needs Trusts

In certain instances, a special needs trust may be prudent.  A special needs trust is a document you create to provide for a beneficiary who has a disability, chronic illness, or injury and relies on government assistance. A special needs trust helps to improve a disabled individual’s life by increasing the longevity of funds using government benefits. It also pays for expenses that are not otherwise covered by government assistance.

A person with a disability may be rendered ineligible for Medicaid, Supplemental Security Income (SSI), or other public benefits if they receive an inheritance or simply accumulate too much money in their account. Any amount over $2,000 in assets will negatively affect benefit eligibility. An individual special needs trust offers a way to protect the assets of a person with a disability while preserving their ability to receive public benefits. Funds can be distributed, as needed, to pay for extra care beyond what the government provides. An individual special needs trust may offer a way to pay for: personal care attendants, home furnishings or modifications, out-of-pocket medical or dental care, education, recreation and vacations, transportation, rehabilitation, and many other ways of improving the quality of life for a person with a disability.

There are two main government benefits that putting money in a trust can preserve:

Medicaid. This program helps individuals and families with disabilities pay for health costs and is the principal source of long-term coverage for many.  This includes skilled nursing facilities and in-home caregiving support (depending on the state).

Supplemental Security Income (SSI). This taxpayer-funded program is allotted to those with disabilities to help them pay for basic needs such as food, clothing, and shelter.

In general, there are two types of special needs trusts (SNTs):

First-party special needs trust, also referred to as a “self-settled” trust, is established using assets of the person with special needs. The beneficiary of the trust must be someone with special needs or who is disabled. The trust is actually established by a parent, grandparent, guardian of the person with special needs, or by a court; however, it is funded using assets owned by the beneficiary. This type of special needs trust is most frequently needed when someone with special needs (or a disabled individual) receives a lump sum of money. For example, if the individual received a settlement for injuries in a personal injury accident or received an inheritance. With a first-party trust, any assets remaining in the trust upon the death of the beneficiary must be used to pay back Medicaid (assuming the beneficiary was a Medicaid recipient). By contrast, with a third-party special needs trust there is no need to worry about repaying Medicaid.

A third-party special needs trust is established by a third party with assets owned by the third party for the benefit of a person with special needs. This type of trust is most often established by a parent, or other family member, for the benefit of a child with special needs. A third-party special needs trust is funded using assets gifted by the parent, grandparent, or other family members. This type of trust must include specific language and must be worded such that the assets in the trust are actually distributed to a third party, such as the parent, to be used for the benefit of the individual with special needs. Because the assets held in the trust are not available to the beneficiary, those assets do not disqualify the beneficiary from eligibility for assistance programs such as Medicaid and SSI.

Both first-party and third-party SNTs must be properly drafted in order to protect a beneficiary’s right to receive means-tested public benefits. The tax consequences of SNTs are very complex. To best protect the government benefits for which an individual with disabilities may be eligible, it is important to discuss which type of SNT should be used in a specific situation with an attorney who is proficient in special needs planning.

While the rules governing your special needs trust will depend on your circumstances and the amount of funds you have available, there are some general special needs trust rules you should know related to qualified disbursements and record keeping. Learning these will help you preserve your or your loved one’s Supplemental Security Income and/or Medicaid, as well as create and administer your trust properly.

Life and Disability Insurance Protection

Life and disability insurance need to be evaluated properly with respect to your children’s needs. Life insurance can pay for the things you’d like your family to have, such as a paid-off mortgage, school tuition, or other significant expenses. Life insurance can help protect your growing family by making sure financial resources are available to them if you’re no longer there and can provide peace of mind for your partner and loved ones.

Disability insurance can also be a major help if one or both parents become unable to work due to a disabling illness or injury. While you may have employer-provided disability insurance, it is important to ensure that it will be enough to cover essential expenses like your mortgage, debt, childcare, and household expenses for a reasonable length of time. Some policies may pay benefits only if you can’t perform any work at all, rather than being unable to do the specific type of work you currently do.

Safeguard Your Child’s Financial Health

All of these are strategies that can help you plan for the future and safeguard your child’s well-being.  Taking many of these steps can help provide peace of mind, knowing that your children will grow up financially secure.  Saving money to secure your child’s future can help give them the advantage they need to succeed in life.