Happy Parenthood! 3 Tax Planning Moves To Consider Making For Your New Child

By Jeffery Levine, IRA Technical Expert  

Follow Me on Twitter: @IRAGuru4EdSlott

I’m still having a hard time believing it’s true, but by the end of tomorrow, I’m going to become a father for the first time. I am obviously super excited and can’t wait to experience all the joys – and even some of the pains – of fatherhood. I know that being a father is nothing to take lightly and there are many responsibilities. Some of the responsibilities are financially-oriented and for a few of those, there are tax efficient ways of achieving one’s goals.

Now obviously, everybody’s situation is different, but below are 3 tax-planning moves I plan to make as soon as possible once I become a father. Perhaps one or more of them is relevant for you and your planning.
 

1. Fund a 529 Plan – 529 plans are great way to save money for a child’s education. These accounts, like IRAs, allow you to accumulate funds on a tax-favored basis. Although there is no federal income tax deduction for contributions to a 529 plan, funds grow tax-deferred while in a 529 account and, if distributions are used to pay qualified higher education costs, those distributions are tax-free. Plus, although there is no federal income tax deduction available, many states offer a state income tax break for contributions made by its residents to its own plan. Just like IRAs, the earlier one starts saving in a 529 plan, the better off they will be. With higher education costs continuing to sky rocket, I’m going to start as early as I can!
2. Attempt to Establish a Roth IRA as Soon as Possible – There are no minimum age requirements to open a Roth IRA. In theory, even a newborn can have one. The key, however, is that a person, regardless of age, needs some sort of “compensation” to make a Roth IRA contribution. Usually, that compensation is some sort of earned income. Now you might ask, “How can a newborn have earned income?” Well, there are a number of ways. Perhaps you own a business and you use your child’s likeness on marketing material. You could pay them for that, legitimately of course. Then, an amount equal to that earned income could be contributed to their Roth IRA (provided they meet the other requirements). I personally have no idea when my child will generate earned income. Maybe it will be soon. Maybe not for 20 or more years. That said, whenever the time comes, I am going to do everything in my power to start his tax-free retirement savings off as early as possible, even if it means I have to make a contribution to his Roth IRA with my own money.
3. Update my Beneficiary Forms – Updating one’s beneficiary forms doesn’t sound like a tax-planning move, but instead, simply an estate planning move. In reality, it is both. Designated beneficiaries – generally living, breathing people named on the beneficiary form – are able to stretch distributions over their life expectancy. This helps an account grow tax-deferred as long as possible and minimize the tax impact on any distributions.

If something were to happen to me in the near future and my son were to inherit my retirement funds, he would be able to distribute those funds over more than an 80-year period.