Baby Steps: 3 Financial Planning Ideas for Expectant Parents

Baby Larz arrived in mid-July 2023, nearly two weeks past his due date. But we were ready for him months before. The crib, the bassinet, the car seat, the bottles, the onesies, and the posh cloth diapers had all been purchased, waiting for their new occupant. While mom was focused on getting the “stuff,” I worked on getting our financial (rubber) ducks in a row before the sleepless nights began.

Here are three financial planning ideas that expectant parents can implement before baby arrives.

#1 – Pre-fund a 529 plan to cover higher education expenses
The 529 plan is the go-to investment vehicle to save for college. The main attractions include tax-deferred growth, tax-free withdrawals when used for qualified higher education expenses, and favorable financial aid treatment.

Typically, a parent opens a 529 with their child as the beneficiary. But the plan owner (the parent) has the flexibility to change the beneficiary to any eligible family member in the future. I took advantage of this rule to open a 529 plan well before Larz’s birthday.

Back in December 2022, I seeded a 529 plan with my wife as the beneficiary and contributed to it as often as I could afford. The timing turned out quite well as the stock market rebounded from 2022’s lows. As soon as Larz’s Social Security card arrived in August, he (an eligible family member) replaced my wife as beneficiary with a head start on his college fund from seven months of contributions and market appreciation.

The SECURE 2.0 Act, passed into law last year, offers an incentive to early 529 adopters. Under the new rules, an account owner can roll up to $35,000 from a 529 plan into a Roth IRA for the beneficiary, eliminating the worry of overfunding the account. But the account must be in existence for 15 years before the rollover, and the most recent five years of contributions are ineligible. By the time Larz is 14½, his 529 will be 15 years old, so I’ll be able to fund a Roth for him, regardless of his earned income. Lastly, having a 529 plan in place early helps encourage gifts from family who know the money will be used for education expenses instead of diapers or golf.

#2 – Purchase a term life insurance policy within the right structure
As a parent, you have to plan for the unexpected and that means upping your life insurance coverage beyond what you might already get through your employer. Term insurance is often the best solution to cover the major family expenses for a defined period of time, usually through college. Rules of thumb can help determine how much coverage you need (i.g. 10x income + $250k per kid) or you can tally up how much debt you’d need to extinguish, income you’d want to replace, and future expenses you’d want to cover.

For Larz, that meant adding a $1 million 25-year term policy to what I’d already purchased when our daughter was born 3 years earlier. At that time, we met with an estate planning attorney who set us up with the standard documents – will, power of attorney, health care proxy, and a revocable trust.

The value of an estate plan cannot be overstated, and like good financial planning advice, the expense is well worth it. Our attorney advised us that we’d save at least $250,000 in estate taxes by setting up an Irrevocable Life Insurance Trust a.k.a. ILIT (pronounced eye-lit). While life insurance proceeds are exempt from income taxes, they’re subject to estate taxes. The $25.84 million federal estate tax exemption is plenty for most Americans, but each state has its own limit. Some mirror the federal exemption, but “Taxachusetts,” where I live, taxes estates over $1 million at rates ranging from 6% to 16%.

When the ILIT owns the life insurance policy, we learned, federal and state estate taxes would be avoided completely when/if the policy pays out. The cost to set up the trust was a one-time fee of $1,500 to potentially save 167x that amount in taxes. I still haven’t found an investment with a better payoff.

It took about two months to get the trust and life insurance in force, so starting the process early is essential. Life insurance may be all you need, but check with your financial advisor, attorney, or accountant to see if you’ve optimized for the current tax regime.

#3 – Choose a High Deductible Health Plan with a Health Savings Account
With open enrollment coming up, now is the time to consider what health insurance plan is best for your family, especially if there’s a large expense on the horizon. I’ve opted for the High Deductible Health Plan option because it offers a lower monthly premium, caps my annual deductible and out-of-pocket expenses, and allows me the opportunity to invest in a triple tax-advantaged account.

While the cost for labor and delivery was nearly $10,000, the HDHP limited my deductible to $3,000. For the rest of the calendar year, I won’t have to pay any more deductibles now that my limit has been hit. This allows my family to optimize our health care needs by accelerating medical appointments and treatments (i.e. dermatologist, physical therapy, chiropractor etc.) in 2023 before the deductible limit resets on January 1. This is akin to taxable investors tax loss harvesting to pull losses into the current year to offset gains.

Arguably the most advantageous retirement planning vehicle in existence, Health Savings Accounts are only available to participants in a High Deductible Health Plan. The HSA allows the insured to invest money for future health care expenses. Contributions are tax deductible, earnings growth tax-deferred, and withdrawals are tax-free if used for qualified expenses.

Many employers offer an incentive to use the HSA by funding a portion of the annual contribution limit. For 2023, the family contribution limit is $7,750. One simple observation I’ve made over the years: If the government puts a limit on how much you can contribute to an account, it’s usually because it’s a good deal for you and bad deal for them. HSAs, Roth IRAs, and recently Treasury I-Bonds all fit this mold.

The ultimate HSA hack is to pay your deductible ($3,000 in my case) out of pocket and keep the capital base intact so it can grow. You don’t have to withdraw from the HSA when the qualified health care expense is incurred, even though they give you a debit card to do so. Just leave the money in there and let it grow tax-deferred for the next 10, 15, or 20+ years.

In my example, I contributed $3,000 of my annual $7,750 limit on January 1. Those funds were invested in an S&P 500^® index fund that grew by 18% to $3,540 by the time Larz was born. I could have withdrawn $3,000 and left the $540 to grow, but instead I paid the deducible out of pocket so the full $3,540 is growing with the S&P 500^®. Simultaneously I became creditor to my HSA account with a $3,000 receivable due on-demand any time in the future. I can let the money grow for decades, but when I submit for reimbursement, I’ll get that money out tax-free because I’ll be submitting a receipt showing a qualified expense paid in 2023. With no income limits, use-it-or-lose-it rules, or mandatory distributions, the HSA has become an extremely powerful retirement savings vehicle.

To Wrap Up
While not an exhaustive list, these are three steps I took to better my family’s financial well-being before baby Larz arrived. I hear someone crying now. I think I know who it is.