Making the most of the "childcare raise"

Shelly Gigante

By Shelly Gigante
Shelly Gigante specializes in personal finance issues. Her work has appeared in a variety of publications and news websites.
Posted on Jun 7, 2022

Preschool graduation is a bittersweet milestone for many families, filled with hopes for their little one’s future and the realization of just how fast the years fly by. But it’s also an opportunity to put some extra money back in their pocket. In some cases, a lot more.

If your child is bound for public elementary school, your disposable income may jump considerably when you write the last check for day care, regardless of whether you still require child care coverage after school. It’s like getting an instant raise.

According to the most recent data from Child Care Aware of America, the national average price of child care is roughly $10,200 per child, consuming more than 10 percent of household income for the average married couple with children under age 18 (based on median income).1 For single parents, the cost of child care accounts for 35 percent of their average household income.

Apart from the immediate savings of no longer having to pay for day care, parents who adjusted their work schedule when their kids were born may also feel liberated to resume their career if they took time off, transition back to full-time hours, or switch to a more demanding (and better paying) job, any one of which might further augment their disposable income.

As with any sudden windfall or substantial raise, you’ll want to capitalize on the opportunity to put those dollars to best use.

“The biggest mistake is to do nothing,” said Christopher Stappas, a financial professional with Summit Financial LLC in Parsippany, New Jersey. “I see this all the time, even with wealthy clients. You need a plan, and you need to stick with it.”

In a sea of competing financial priorities, he said, these are the buckets into which young families should consider funneling newfound income:

As you reallocate your child care dollars, keep in mind that your priorities may change as your financial picture evolves. You may also fund multiple goals simultaneously. 

“A typical client will have eight or nine various buckets, broken into short-term, medium-term, and long-term events and accounts,” said Daniel Drabinski, a financial professional with Bluecrest Financial Alliances in Dallas, Texas. “Solving this puzzle of where to put funds is often the secret sauce of planning. Only the client can determine their individual priorities or decide where they want to focus their excess money.”

A financial professional can provide guidance.

Disability income insurance

Your first order of business is to conduct a needs analysis to identify any holes that may exist in your financial plan, said Stappas. That begins with insurance protection.

“Before you do anything, you 100-percent need to close the barn door to be sure your family is protected,” said Stappas. “If you were suddenly not here tomorrow or you could no longer produce an income, what would your family need to stay in their home, put food on the table, and educate your children?”

Disability income (DI) insurance, which is designed to replace a portion of your income if you are unable to work due to a qualifying illness or injury, is critical. You can also estimate your coverage needs using the MassMutual disability income insurance calculator.

“DI insurance protects your greatest asset, which is your ability to provide income and support for your loved ones,” said Stappas.

Disabilities may be more common than you think. In fact, one in four 20-year-olds will become disabled before they reach retirement age, more often from arthritis, back pain, neurological problems, or cardiovascular illnesses than from injuries, according to the Social Security Administration.2

Many working adults mistakenly believe that the group disability income insurance they receive through their employer is sufficient for their family. But group coverage often falls short because:

  • The DI coverage may not provide a big enough benefit.
  • Group policies may include restrictions that limit benefits.
  • The policy may not be portable, meaning you may not be able to take the policy with you after you leave your job, at which point premiums for a new private policy may be cost prohibitive due to increased age or a newly developed medical condition.

According to financial professionals, most adults who rely on their income for living expenses, or have family members who depend on them financially, should consider purchasing a private DI insurance policy to pick up where their employer-sponsored policy leaves off. (Learn more: 6 ways group disability income insurance may fall short)

Life insurance

Your next priority, said Drabinski, should be life insurance, an important pillar of any financial plan that can ensure your loved ones will be able to maintain their standard of living if you should pass away prematurely.

The amount and type of coverage you may need all depends on your unique financial profile. Here again, a financial professional can offer invaluable guidance. MassMutual’s life insurance calculator can provide a rough assessment of your potential coverage needs.

Term life insurance is the least expensive option, providing a death benefit only if the insured dies during the policy’s term — often 10, 20, or 30 years.

By contrast, permanent life insurance (whole, universal, or variable) provides a guaranteed payout to the beneficiaries as long as the policy is in force when the insured dies. Because of the lifetime protection, it tends to be more expensive. But it also includes other features.

For example, a permanent life insurance policy also accumulates cash value that can potentially be used penalty free and on a tax-advantaged basis during the policyowner’s lifetime to supplement retirement savings, pay for college, or for any other financial need. Keep in mind that access to cash value through borrowing or partial surrenders will reduce the policy’s cash value and death benefit and increase the chance the policy will lapse. If this happens, it may result in a tax liability.

Stappas said he often counsels younger clients to start off with a convertible term life insurance policy so that they can maximize the amount of their coverage at the lowest cost. Then, as their disposable income grows, he typically recommends that they convert to permanent life insurance. (Learn more: What you should know about term-perm conversions)

Emergency fund

As you repurpose the dollars you once earmarked for day care, look next to your emergency fund.

“An emergency fund, coupled with disability income insurance and sufficient life insurance are the first line of defense when it comes to risk protection,“ said Drabinski.

An emergency fund can help pay the bills if you experience a sudden job loss, medical emergency, or any other unexpected expense, so you don’t have to rely on high-interest credit card debt.

Yet, most households do not have adequate savings. According to MassMutual’s 2018 State of the American Family survey, more than half (52 percent) of families with household income of $50,000 or more and at least one dependent had less than three months’ worth of readily available savings set aside. Roughly 8 percent had nothing at all.

Most financial professionals recommend having at least three to six months' worth of living expenses set aside in a liquid, interest-bearing account, such as a savings or money market account. If you are self-employed, a single-income household, or your income stream is unpredictable, you may need up to a year’s worth of living expenses saved. (Related: How to create an emergency fund)

“This does not necessarily need to sit in cash, but it should be readily accessible within 48 hours,” said Drabinski.

Debt

Debt is a pothole on the road to financial freedom. It reduces your disposable income and limits your ability to meet other financial goals, such as saving for retirement or a new home. Worse, it forces those who carry a monthly credit card balance to overpay for the products they purchase.

Assuming an 18 percent interest rate, for example, that $1,800 laptop you paid for with plastic would take 8 years and 3 months to pay off and cost a total of $3,115 if you made only the minimum monthly payments, according to the minimum payment calculator on WalletHub.

That said,not all debt is bad.

“Good debt includes something which enhances your livelihood, safety, or hire-ability, such as school loans or a competitively priced mortgage,” said Drabinski. “This debt can be managed or paid down over time.”

Bad debt, on the other hand, includes high interest credit cards, retail cards, or high interest loans. 

“We tend to focus on aggressively paying off bad debts,” said Drabinski. “This is the area that causes the most stress, and where we spend most of our time aggressively pursuing whenever we have excess cash flow.” (Learn more: Understanding good debt versus bad debt)

Retirement

If you’re not already maxing out your retirement plan, consider using your “day care bonus” to increase your annual contribution.

The MassMutual retirement income calculator can provide a ballpark estimate of how much you may need to retire comfortably. Some age-based guidance should also help:

  • How much you should have saved in your 20s.
  • How much you should have saved in your 30s.
  • How much you should have saved in your 40s and 50s.

Remember that your financial goals are not mutually exclusive. You can and should fund your retirement account (at least enough to get the employer match) while paying down debt and saving into an emergency fund. Remember, due to the benefits of compounded growth, there is no substitute for saving early. (Learn more: Why saving for retirement early is important)

Contributions to a tax-deferred retirement account, such as a 401(k) or traditional IRA, also helps to lower your taxable income in the year you contribute. Tax efficiency helps your savings work harder. 

“As a general rule, one should take advantage of whatever tax breaks the IRS is willing to give you so long as you can afford to give up the immediate use of that income,” said Drabinski. “Certainly, if one is fortunate to receive a 401(k) match through their company, they should maximize that benefit at a minimum.”

Short-term and middle-term financial goals

Once your family is protected and you’ve put your retirement savings on autopilot, you can begin directing extra income toward short-term and medium-term goals. That gets easier as you pay down debt and finish funding your emergency account.

Such goals may include buying a new home, an important steppingstone to building wealth. But coming up with the down payment is a challenge for many young families, especially with average home prices on the rise. (Learn more: Buying your first home)

Don’t let that deter you. There are a number of creative ways to get your piece of the American dream. For example, you might qualify for down-payment assistance programs, or put less than 20 percent down and pay private mortgage insurance to get in the door. You could also potentially request a gift or a loan from loved ones. (Learn more: How to gather a home down payment)

College saving is yet another priority for many parents. And it’s a big nut to crack. According to the College Board, annual tuition, fees, and room and board for full-time students averaged $27,330 for in-state students at public four-year colleges and universities, $44,150 for nonresidents at public four-year colleges and universities, and $55,800 at private nonprofit four-year colleges for the 2021-2022 academic year.3

A 529 plan can help you save smart. (Learn more: Getting the most out of your 529 plan)

“529 plans offer great tax benefits,” said Stappas. “Not only do you get tax-deferred growth, but also tax-free distributions if the money is used for qualified education expenses. That’s one of the only savings vehicles that does that.”

While noble, however, just remember that it’s not part of the job description to give your kids a full ride. Never save for your children’s college education at the expense of your retirement. They can get loans and you can still support them by encouraging their progress and helping them keep their costs under control. (Learn more: 6 ways to cut college costs in half)

Conclusion

As your kids age out of preschool, you need a plan to put those savings to work.

By doing an assessment of their insurance needs, fortifying their emergency fund, and boosting their retirement plan contributions, they can better position themselves to protect their family and reach their financial goals.

“Maintaining a margin of safety is the single most important thing you can do in order to provide the security and confidence your family needs to excel,” said Drabinski. “If you are constantly worried about making ends meet, it is very hard to take career risks and dream about bigger goals for your family.”

Discover more from MassMutual…

Managing debt in a balanced way with savings

The pandemic and financial lessons for kids

Need a financial professional? Find one here

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1 Child Care Aware of America, “Demanding Change: Repairing Our Child Care System,” February 2022.

2 Social Security Administration, “Fact Sheet: Social Security Disability Insurance," March 2021.

3 College Board, “Trends in College Pricing and Student Aid 2021.”

The information provided is not written or intended as specific tax or legal advice. MassMutual and its subsidiaries, employees, and representatives are not authorized to give tax or legal advice. You are encouraged to seek advice from your own tax or legal counsel. Opinions expressed by those interviewed are their own and do not necessarily represent the views of MassMutual.