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Becoming a Parent

by admin
02 Aug 2024

Your Child’s Education: How To Finance It

How can you properly fund your children’s education without draining your current cash flow? What should you do if they are a few years away from college and your education fund won’t be enough? How can you increase your chances of getting financial aid? What tax benefits might be available to you? This Financial Guide answers these questions.

With the costs of a college education rising every year, the keys to funding your child’s education are to plan early and invest shrewdly. However, there are steps you can take if you get a late start. Moreover, there are a number of effective techniques for increasing financial aid opportunities and reducing taxes. Here are some guidelines for funding your child’s education that are geared to parents whose children are no older than elementary school age.

  • Start Saving Early
  • Find Out How Much You’ll Need To Save
  • Choose Your Investments
  • If You’re Caught Short
  • Sources Of Financial Aid
  • Planning Techniques
  • How To Increase The Amount Of Financial Aid
  • How To Reduce Taxes
  • Government and Non-Profit Agencies
Start Saving Early

College is expensive and proper planning can lessen the financial squeeze considerably – especially if you start when your child is young. Getting an early start on saving is basic to funding your child’s education. The earlier you start, the more you’ll benefit from the compounding of interest.

Planning Aid: For an estimate of the amount of money you would have at the time your child enters college if you begin saving now, see the Financial Calculator: College Savings Calculator.

When should you start saving? This depends on how much you think your children’s education will cost. The best way is to start saving before they are born. The sooner you begin, the less money you will have to put away each year.

Suppose you have one child, age six months, and you estimate that you’ll need $120,000 to finance his college education 18 years from now. If you start putting away money immediately, you’ll need to save $3,500 per year for 18 years (assuming an after-tax return of seven percent). On the other hand, if you put off saving until the child is six years old, you’ll have to save almost double that amount every year for twelve years.

Another advantage of starting early is that you’ll have more flexibility when it comes to the type of investment you’ll use. You’ll be able to put at least part of your money in equities, which, although riskier in the short-run, are better able to outpace inflation than other investments after time.

Find Out How Much You’ll Need To Save

How much will your child’s education cost? It depends on whether your child attends a private or state school. According to the College Board, for the 2022-23 school year the total expenses – tuition, fees, board, personal expenses, and books and supplies – for the average four-year private college are about $57,570 per year and about $27,940 per year for the average four-year in-state public college. However, these amounts are averages: the tuition, fees, and board for some private colleges can exceed $80,000 per year whereas the costs for a state school can often be kept under $10,000 per year. It should also be noted that in 2022-23 the average amount of grant aid for a full-time undergraduate student was about $8,690 and $24,770 for four-year public and private schools, respectively. More than 75 percent of full-time students at four year colleges and universities receive grant aid to help pay for college.

Planning Aid: Use College Search, a database of over 3,200 two-and four-year colleges, to find and select the best colleges for your child.

Planning Aid: If you’re trying to estimate future costs, you can estimate that school costs will grow by about two percentage points above the inflation rate. To be on the safe side, we suggest you assume costs will grow by at least 4 percent per year. For the most recent increases, refer to Trends in College Pricing.

Choose Your Investments

As with any investment, you should choose those that will provide you with a good return and that meet your level of risk tolerance. The ones you choose should depend on when you start your savings plan-the mix of investments if you start when your child is a toddler should be different from those used if you start when your child is age 12.

Related Financial Guide: For a general overview of investing principles, please see the Financial Guide: INVESTMENT BASICS: What You Should Know.

The following are often recommended as investments suitable for education funds:

Series EE Bonds are extremely safe investments. For tax treatment of redemption proceeds used for college, please see the Financial Guide: HIGHER EDUCATION COSTS: How To Get The Best Tax Treatment.

U.S. Government Bonds are also safe investments that offer a relatively higher return. If you use zero-coupon bonds for your child’s education, you can time the receipt of the proceeds to fall in the year when you need the money. A drawback of such bonds is that a sale before their maturity date could result in a loss on the investment. Further, the accrued interest is taxable even though you don’t receive it until maturity.

CDs are safe, but usually provide a lower return than the rate of inflation. The interest is taxable.

Municipal Bonds, if they are highly rated, can provide an acceptable return from the tax-free interest if you’re in the higher income tax brackets. Zero-coupon municipals can be timed to fall due when you need the funds and are useful if you begin saving later in the child’s life.

Be sure to convert the tax-free return quoted by sellers of such bonds into an equivalent taxable return. Otherwise, the quoted return may be misleading. The formula for converting tax-free returns into taxable returns is as follows:

Divide the tax-free return by 1.00 minus your top tax rate to determine the taxable return equivalent. For example, if the return on municipal bonds is 5 percent and you are in the 30 percent tax bracket, the equivalent taxable return is 7.1 percent (5 percent divided by 70 percent).

Stocks contained in an appropriate mutual fund or portfolio can provide you with a higher yield at an acceptable risk level. Stock mutual funds can provide superior returns over the long term. Income and balanced funds can meet the investment needs of those who begin saving when the child is older.

Deferred Annuities provide you with tax deferral, but the yield may not be acceptable because of the relatively high cost of these investments. Further, amounts withdrawn before you reach age 59-1/2 may be subject to a 10 percent premature withdrawal penalty.

Related Financial Guide: For further information on investing in annuities, please see the Financial Guide: ANNUITIES: How They Work And When You Should Use Them.

If You’re Caught Short

If you have insufficient savings for your child’s education when he or she is close to entering college, there are ways to generate additional funds both now and when your child is about to enter school:

  1. You can start saving as much as possible during the remaining years. However, unless your income level is high enough to support an extremely stringent savings plan, you will probably fall short of the amount you need.
  2. You can take on a part-time job. However, this will raise your income for purposes of determining whether you are eligible for certain types of student aid. In addition, your child may be able to take on part-time or summer jobs.
  3. You can tap your assets by taking out a home equity loan or a personal loan, selling assets or borrowing from a 401(k) plan.
  4. You (or your child) can apply for various types of student aid and education loans (discussed below and in Info Sources).

Related Financial Guide: For further information on Equity Loans, please see the Financial Guide: HOME EQUITY LOANS: How To Shop For The One That’s Best For You.

Sources of student aid and education loans should be exhausted before other types of loans are used, since the former make better sense financially. In some cases, however, a home equity loan can be advantageous because of the deductibility of interest.

Sources Of Financial Aid

Here is a summary of the possible sources of financial aid. The types of aid and tax implications change frequently, so consult your financial advisor for specifics when you’re approaching the time to seek financial aid.

Grants, the best type of financial aid because they do not have to be paid back, are amounts awarded by governments, schools, and other organizations. Some grants are need-based and others are not.

  • Federal Pell Grant Program. Pell grants are need-based.

Don’t assume that middle class families are ineligible for need-based aid or loans. The assessment of whether a family qualifies as “in need” depends on the cost of the college and the size of the family.

  • State education departments may make grants available. Inquiries should be made of the state agency. Employers may provide subsidies.
  • Private organizations may provide scholarships. Inquiries should be made at schools.
  • Most schools provide aid and scholarships, both need-based and non-need-based.
  • Military scholarships are available to those who enlist in the Reserves, National Guard, or Reserve Officers Training Corps. Inquiries should be made at the branch of service.

Try negotiating with your preferred college for additional financial aid, especially if it offers less than a comparable college.

Loans may be need-based, and others are not. Here is a summary of loans:

  • Stafford loans (formerly guaranteed student loans) are federally guaranteed and subsidized low-interest loans made by local lenders and the federal government. They are need-based for subsidized loans; however, an unsubsidized version is also available.
  • Perkins loans are provided by the federal government and administered by schools. They are need-based. Inquiries should be made at school aid offices.
  • Parent loans for undergraduate students (PLUS) and supplemental loans for students are federally guaranteed loans by local lenders to parents, not students. Inquiries should be made at college aid offices or by calling 800-333-4636.
  • Schools themselves may provide student loans. Inquiries should be made at the school.

Work-Study Programs. This is a program that is federally funded and based on the family’s financial need. The student works on-campus and receives partly subsidized pay. The receipt of work-study funds does not affect the level of “need” for purposes of need-based grants and loans.

To make a thorough investigation, you should fill out the financial aid application, which you can obtain from the school’s financial aid office. You will have to provide tax returns. The amount you are determined to be eligible for depends on your income, the size of your family, the number of family members currently attending college, and your assets.

Planning Techniques

Related Financial Guide: For information on Equity Loans, please see the Financial Guide: HOME EQUITY LOANS: How To Shop For The One That’s Best For You.

How To Increase The Amount Of Financial Aid

How To Increase The Amount Of Financial Aid

Here are some strategies that may increase the amount of aid for which your family is eligible:

  1. Try to avoid putting assets in your child’s name. As a general rule, education funds should be kept in the parents’ names, since investments in a child’s name can impact negatively on aid eligibility. For example, the rules for determining financial aid decrease the amount of aid for which a child is eligible by 35 percent of assets the child owns and by 50 percent of the child’s income.

If your child owns $1,000 worth of stock, the amount of aid for which he or she is eligible for is reduced by $350. On the other hand, the amount of aid is reduced by (effectively) only 5.6 percent of your assets and from 22 to 47 percent of your income.

  1. Reduce your income. Income for financial aid purposes is generally determined based upon your previous year’s income tax situation. Therefore, in the years immediately prior to and during college, try to reduce your taxable income. Some ways to do this include:
    • Defer capital gains.
    • Sell losing investments.
    • Reduce the income from your business. If you are the owner of your own business, you may be able to reduce your taxable income by taking a lower salary, deferring bonuses, etc.
    • Avoid distributions from retirement plans or IRAs in these years.
    • Pay your federal and state taxes during the year in the form of estimated payments rather than waiting until April 15 of the following year.
    • Since a portion of discretionary assets is included in the family’s expected contribution from income, reduce discretionary assets by paying off credit cards and other consumer loans.
    • Take advantage of vehicles which defer income, such as 401(k) plans, other retirement plans or annuities.
  2. Detail your financial hardships. If you have any financial hardships, let the deciding authorities know (via the statement of financial need) exactly what they are, if they are not clear on the application. The financial aid officer may be able to assist you in explaining hardships.
  3. Have your child become independent (if feasible). In this case, your income is not considered in determining how much aid your child will be eligible for. Students are considered independent if they:
    • Are at least 24 years old by the end of the year for which they are applying for aid,
    • Are veterans,
    • Have dependents other than their spouse,
    • Are wards of the court or both parents are deceased,
    • Are graduate or professional students or
    • Are married and are not claimed as dependents on their parents’ returns.

How To Reduce Taxes

As noted above, education funds should generally be kept in the parents’ names because of financial-aid considerations. However, in specific cases, it may be better to keep the investments in your child’s name since the tax rate on the income will be less than if they are held in your name. Professional advice should be sought in making this decision.

In the past, parents would invest in the child’s name in order to shift income to the lower-bracket child. However, the addition of the “kiddie tax” mostly put an end to that strategy. Now, investment income over $2,500 for 2023 of children under the age of 19 (or 24 if a full-time student) is taxed at the parents’ rate. Once the child reaches age 19, however, all income is taxed at the child’s rate. Of this $2,500, one-half probably won’t be taxed due to the availability of the standard deduction while the other half would be taxed at the child’s rate.

These rules apply to unearned income. If a child has earned income, this amount is always taxed at the child’s rate. If you decide to invest in your child’s name, here are some tax strategies to consider:

  1. You can shift just enough assets to create $2,500 in taxable income to an under-19 child.
  2. You can buy U.S. Savings Bonds (in the child’s name) scheduled to mature after your child reaches age 19.
  3. You can invest in equities that pay small dividends but have a lot of potential for appreciation. The income earned when your child is under the age of 19 will be minimal, and the growth in the stocks will occur over the long term.
  4. If you own a family business, you can employ your child in the business. Earned income is not subject to the “kiddie tax,” and is deductible by the business if the child is performing a legitimate function. Additionally, if your business is a sole proprietorship and your child is under the age of 19, then he or she will not pay social security taxes on the income.

The Kiddie Tax does not apply if the earned income of a student over age 18 exceeds half of the child’s living expenses. Living expenses include food, housing, clothing, medical, dental, education and other necessary costs of support. Students over 18 are considered independent from their parents if they provide more than 50 percent of their own support.

There are also a number of tax incentives that you might be able to take advantage of. Please see the Financial Guide: HIGHER EDUCATION COSTS: How To Get The Best Tax Treatment.

Reporting the kiddie tax on the child’s return using the required Form 8615, Tax for Certain Children Who Have Unearned Income, calls for showing the parents’ taxable income. A parent reluctant to show that item to a teenager may instead report the child’s investment income of the parent’s return, on Form 8814, Parent’s Election to Report Child’s Interest and Dividends, . But this is not allowed, and the Form 8615 route must be followed, where the child has taxable earned income, as many teenagers would.

Government and Non-Profit Agencies

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by admin
02 Aug 2024

The “Nanny Tax” Rules: What To Do If You Have Household Employees

If you have a household employee, you may need to pay state and federal employment taxes. Which forms do you need to file for your household employees? Is your maid, housekeeper, or babysitter covered by the rules? This Financial Guide provides the answers to these and other questions.

This Financial Guide will help you decide whether you have a “household employee,” as defined by the IRS and if you do, whether you need to pay federal employment taxes. It explains the rules for determining, paying, and reporting Social Security tax, Medicare tax, federal unemployment tax, federal income tax withholding, and state unemployment tax for your household employee. It also explains what records you need to keep. In addition, it provides you with the information you need to find out whether you need to pay state unemployment tax for your household employee.

While many people disregard the need to pay taxes on household employees, they do so at the risk of stiff tax penalties. As you will see below, these rules are quite complex and professional tax guidance is highly recommended.

A basic familiarity with these rules will make it easier to work with your tax advisor, saving you time, reducing tax costs, and avoiding tax penalties and interest charges.

  • Who is a Household Employee?
  • How Do You Verify That an Employee Can Legally Work in the United States?
  • Do You Need to Pay Employment Taxes?
  • State Unemployment Taxes
  • Social Security And Medicare Taxes
  • Federal Unemployment (FUTA) Tax
  • Do You Need to Withhold Federal Income Tax?
  • How Do You Handle The Earned Income Credit?
  • How Do You Make Tax Payments?
  • What Forms Must You File?
  • What Records Must You Keep?
  • State Unemployment Tax Agencies
  • Household Employers Checklist
Who is a Household Employee?

The “nanny tax” rules apply to you only if (1) you pay someone for household work and (2) that worker is your employee.

  1. A household employee is someone who does work in or around your home. Examples of household employees include babysitters, nannies, health aides, private nurses, maids, caretakers, yard workers, and similar domestic workers.
  2. A household worker is your employee if you can control not only what work is done, but how it is done. If the worker is your employee, it does not matter whether the work is full-time or part-time, or if you hired the worker through an agency or from a list provided by an agency or association. It also does not matter whether you pay the worker on an hourly, daily, or weekly basis, or by the job.On the other hand, if only the worker can control how the work is done, the worker is not your employee but is self-employed. A self-employed worker usually provides his or her own tools and offers services to the general public in an independent business. If an agency provides the worker and controls what work is done and how it is done, the worker is not your employee.

You pay Emily to babysit your child and do light housework four days a week in your home. Emily follows your specific instructions about household and childcare duties. You provide the household equipment and supplies that Emily needs to do her work. Emily is your household employee.

You pay Nathan to care for your lawn. Nathan also offers lawn care services to other homeowners in your neighborhood. He provides his own tools and supplies, and he hires and pays any helpers he needs. Neither Nathan nor his helpers are your household employees.

How Do You Verify That an Employee Can Legally Work in the United States?

It is unlawful for you to knowingly hire or continue to employ a person who cannot legally work in the United States.

When you hire a household employee to work for you on a regular basis, he or she must complete USCIS Form I-9, Employment Eligibility Verification. It is your responsibility to verify that the employee is either a U.S. citizen or an alien who can legally work and then complete the employer part of the form. Keep the completed form for your records. Do not return the form to the U.S. Citizenship and Immigration Services (USCIS).

Two copies of Form I-9 are contained in the UCIS Employer Handbook. Visit the USCIS website or call 800-767-1833 to order the handbook, additional copies of the form, or to get more information.

Do You Need to Pay Employment Taxes?

If you have a household employee, you may need to withhold and pay Social Security and Medicare taxes, or you may need to pay federal unemployment tax, or you may need to do both. To find out, read the table below.

If you:

Then you need to:
Pay cash wages of $2,600 or more in 2023 to any one household employee.Do not count wages you pay to:

  • Your spouse,
  • Your child under age 21,
  • Your parent, or
  • Any employee under age 18 during 6
 Withhold and pay Social Security and Medicare taxes.

  • The combined taxes are generally 15.3% of cash wages.
  • Your employee’s share is 7.65%.

(You can choose to pay the employee’s share yourself and not withhold it.)

  • Your share is 7.65%.
Pay total cash wages of $1,000 or more in any calendar quarter of 2022 or 2023 to household employees.Do not count wages you pay to:

  • Your spouse,
  • Your child under age 21, or
  • Your parent.
 Pay federal unemployment tax.

  • The tax is 6.0% of cash wages.
  • Wages over $7,000 a year per employee are not taxed.
  • You also may owe state unemployment tax.

If neither of these two columns applies, then you do not need to pay any federal unemployment taxes. However, you may still need to pay state unemployment taxes.

You do not need to withhold federal income tax from your household employee’s wages. But if your employee asks you to withhold it, you can choose to do so.

If your household employee cares for your dependent under the age of 13 or your spouse or dependent who is not capable of self-care so that you can work, you may be able to take an income tax credit of up to 35% (or $1,050) of your expenses for each qualifying dependent. For two or more qualifying dependents, you can claim up to 35% (or $2,100). For higher-income earners, the credit percentage is reduced, but not below 20%, regardless of the amount of AGI. If you can take the credit, then you can include your share of the federal and state employment taxes you pay, as well as the employee’s wages, in your qualifying expenses.

State Unemployment Taxes

To find out whether you need to pay state unemployment tax for your household employee contact your state unemployment tax agency. You’ll also need to determine whether you need to pay or collect other state employment taxes or carry workers’ compensation insurance.

If you do not need to pay Social Security, Medicare, or federal unemployment tax and do not choose to withhold federal income tax, the rest of this publication does not apply to you.

Social Security And Medicare Taxes

Additional Medicare Tax. As of January 1, 2013, employers are responsible for withholding the 0.9% Additional Medicare Tax on an individual’s wages paid in excess of $200,000 in a calendar year. An employer is required to begin withholding Additional Medicare Tax in the pay period in which it pays wages in excess of $200,000 to an employee. There is no employer match for Additional Medicare Tax.

Both you and your household employee may owe social security and Medicare taxes. Your share is 7.65% (6.2% for social security tax and 1.45% for Medicare tax) of the employee’s social security and Medicare wages. Your employee’s share is 6.2% for social security tax and 1.45% for Medicare tax for wages below the Additional Medicare Tax threshold (see above).

You are responsible for payment of your employee’s share of the taxes as well as your own. You can either withhold your employee’s share from the employee’s wages or pay it from your own funds.

Social Security and Medicare Wages

You figure Social Security and Medicare taxes on the Social Security and Medicare wages you pay your employee. If you pay your household employee cash wages of $2,600 or more in 2023, all cash wages you pay to that employee in 2023 (regardless of when the wages were earned) up to $160,200 are social security wages and all cash wages are Medicare wages. However, any non-cash wages (food, lodging, clothing, and other non-cash items) you pay do not count as social security and Medicare wages. If you pay the employee less than $2,600 in cash wages in 2023, none of the wages you pay the employee are Social Security and Medicare wages, and neither you nor your employee will owe Social Security or Medicare tax.

Wages Not Counted

Do not count wages you pay to any of the following individuals as Social Security and Medicare wages:

  1. Your spouse.
  2. Your child who is under age 21.
  3. Your parent.

    However, you should count wages to your parent if both of the following apply: (a) your child lives with you and is either under age 18 or has a physical or mental condition that requires the personal care of an adult for at least four continuous weeks in a calendar quarter, and (b) you are divorced and have not remarried, or you are a widow or widower, or you are married to and living with a person whose physical or mental condition prevents him or her from caring for your child for at least four (4) continuous weeks in a calendar quarter.

  4. An employee who is under age 18 at any time during the year.

    However, you should count these wages to an employee under 18 if providing household services is the employee’s principal occupation. If the employee is a student, providing household services is not considered to be his or her principal occupation.

Also, if your employee’s Social Security and Medicare wages reach $160,200 in 2023, do not count any wages you pay that employee during the rest of the year as Social Security wages to figure Social Security tax (but continue to count the employee’s cash wages as Medicare wages to figure Medicare tax).

You figure federal income tax withholding on both cash and non-cash wages (based on their value). However, do not count as wages any of the following items:

  • Meals provided at your home for your convenience.
  • Lodging provided at your home for your convenience and as a condition of employment.
  • $300 a month in 2023 for transit passes that you give your employee or, in some cases, for cash reimbursement you make for the amount your employee pays to commute to your home by public transit. A transit pass includes any pass, token, fare card, voucher, or similar item entitling a person to ride on mass transit, such as a bus or train.
  • Up to $300 a month in 2023 to reimburse your employee for the cost of parking at or near your home or at or near a location from which your employee commutes to your home.

Withholding the Employee’s Share

You should withhold the employee’s share of Social Security and Medicare taxes if you expect to pay your household employee Social Security and Medicare wages of $2,600 or more in 2023. However, if you prefer to pay the employee’s share yourself; see “Not Withholding the Employee’s Share” in the next section.

You may withhold the employee’s share of the taxes even if you are not sure your employee’s Social Security and Medicare wages will be $2,600 or more in 2023. If you withhold the taxes but then actually pay the employee less than $2,600 in Social Security and Medicare wages for the year, you should repay the employee.

You pay withheld taxes as part of your regular income tax obligation. You don’t deposit them periodically subject to an exception for business owners. See “Payment Options for Business Employers” below.

Withhold 7.65% (6.2% for Social Security tax and 1.45% for Medicare tax) from each payment of Social Security and Medicare wages. Wages exceeding the $200,000 (single filer) threshold amount are subject to the additional Medicare tax or 0.9%. Instead of paying this amount to your employee, you will pay the IRS 7.65% for your share of the taxes. Do not withhold any social security tax after your employee’s social security wages for the year reach $160,200 in 2023.

If you make an error by withholding too little, you should withhold additional taxes from a later payment. If you withhold too much, you should repay the employee.

You hire a household employee (who is an unrelated individual over age 18) to care for your child and agree to pay cash wages of $100 every Friday. You expect to pay your employee $2,200 or more for the year. You should withhold $7.65 from each $100 wage payment and pay your employee the remaining $92.35. The $7.65 is the sum of $6.20 ($100 x 6.2%) for your employee’s share of Social Security tax and $1.45 ($100 x 1.45%) for your employee’s share of Medicare tax (for wages under $200,000 for single filers). You will pay $7.65 from your own funds when you pay the taxes.

Not Withholding the Employee’s Share

If you prefer to pay your employee’s Social Security and Medicare taxes from your own funds, you do not have to withhold them from your employee’s wages. The Social Security and Medicare taxes you pay to cover your employee’s share must be included in the employee’s wages for income tax purposes. However, they are not counted as Social Security and Medicare wages or as federal unemployment (FUTA) wages.

You hire a household employee (who is an unrelated individual over age 18) to care for your child and agree to pay cash wages of $100 every Friday. You expect to pay your employee $2,200 or more for the year. You decide to pay your employee’s share of Social Security and Medicare taxes from your own funds. You pay your employee $100 every Friday without withholding any Social Security or Medicare taxes. For each wage payment, you will pay $15.30 when you pay the taxes. This is $7.65 ($6.20 for Social Security tax plus $1.45 for Medicare tax) to cover your employee’s share plus the $7.65 for your share. For income tax purposes, your employee’s wages each payday are $107.65 ($100 plus the $7.65 that you will pay to cover your employee’s share of Social Security and Medicare taxes).

Federal Unemployment (FUTA) Tax

The federal unemployment tax is part of the federal and state program under the Federal Unemployment Tax Act (FUTA) that pays unemployment compensation to workers who lose their jobs. Like most employers, you may owe both the federal unemployment tax (the FUTA tax) and a state unemployment tax. Or, you may owe only the FUTA tax or only the state unemployment tax. To find out whether you will owe state unemployment tax, contact your state’s unemployment tax agency. See the list of state unemployment agencies at the end of this Guide for the address.

The FUTA tax is 6.0% of your employee’s FUTA wages. However, you may be able to take a credit of up to 5.4% against the FUTA tax, resulting in a net tax rate of 0.6%. Your credit for 2023 is limited unless you pay all the required contributions for 2023 to your state unemployment fund by April 15, 2024. The credit you can take for any contributions for 2023 that you pay after April 15, 2024, is limited to 90% of the credit that would have been allowable if the contributions were paid on or before that day.

The 5.4% credit is reduced for wages paid in a credit reduction state. See the Instructions for Schedule H (Form 1040).

Do not withhold the FUTA tax from your employee’s wages. You must pay it from your own funds.

You figure the FUTA tax on the FUTA wages you pay. If you pay cash wages to all of your household employees totaling $1,000 or more in any calendar quarter of 2022 or 2023, the first $7,000 of cash wages you pay to each household employee in 2023 is FUTA wages. (A calendar quarter is January through March, April through June, July through September, or October through December.) If your employee’s cash wages reach $7,000 during the year, do not figure the FUTA tax on any wages you pay that employee during the rest of the year. For a discussion of “cash wages,” see the section on Social Security Wages, above.

If you pay less than $1,000 cash wages in each calendar quarter of 2023, but you had a household employee in 2022, the cash wages you pay in 2023 may still be FUTA wages. They are FUTA wages if the cash wages you paid to household employees in any calendar quarter of 2022 totaled $1,000 or more.

Do not count wages you pay to any of the following individuals as FUTA wages:

  1. Your spouse.
  2. Your child who is under age 21.
  3. Your parent.

You hire a household employee (not related to you) on January 1, 2023, and agree to pay cash wages of $200 every Friday. During January, February, and March, you pay the employee cash wages of $2,600. Because you pay cash wages of $1,000 or more in a calendar quarter of 2023, the first $7,000 of cash wages you pay the employee (or any other employee) in 2023 or 2022 is FUTA wages. The FUTA wages you pay may also be subject to your state’s unemployment tax.

During 2023, you pay your household employee cash wages of $10,400. You pay all the required contributions for 2023 to your state unemployment fund by April 15, 2024. Your FUTA tax for 2023 is $42 ($7,000 x 0.6%).

Do You Need to Withhold Federal Income Tax?

You are not required to withhold federal income tax from wages you pay a household employee. You should withhold federal income tax only if your household employee asks you to withhold it and you agree. The employee must give you a completed Form W-4, Employee’s Withholding Allowance Certificate.

Form W-4, Employee’s Withholding Certificate, was redesigned in 2020.

If you agree to withhold federal income tax, you are responsible for paying it to the IRS.

Wages

You figure federal income tax withholding on both cash and non-cash wages you pay. Measure wages you pay in any form other than cash by the value of the non-cash item.

Do not count as wages any of the following items:

  • Meals provided at your home for your convenience.
  • Lodging provided at your home for your convenience and as a condition of employment.
  • Up to $300 a month in 2023 for bus or train tokens (passes) you give your employee, or for any cash reimbursement you make for the amount your employee pays to commute to your home by public transit.
  • Up to $300 a month in 2023 for the value of parking you provide your employee at or near your home or at or near a location from which your employee commutes to your home.

Paying Tax without Withholding

Any income tax you pay for your employee without withholding it from the employee’s wages must be included in the employee’s wages for federal income tax purposes. It is also counted as Social Security and Medicare wages and as federal unemployment (FUTA) wages.

How Do You Handle The Earned Income Credit?

Certain workers can take the earned income tax credit (EITC) on their federal income tax return. This credit reduces their tax or allows them to receive a payment from the IRS if they do not owe tax. You may have to make advance payments of part of your household employee’s EITC along with the employee’s wages. You also may have to give your employee a notice about the EITC.

Notice about the EITC

The employee’s copy (Copy B) of IRS 2023 Form W-2, Wage and Tax Statement has a statement about the EITC on the back.

If you give your employee that copy by January 31, 2023 (as discussed under Form W-2), you do not have to give the employee any other notice about the EITC.

Otherwise, you must give your household employee a notice about the EITC only if you agree to withhold federal income tax from the employee’s wages but the income tax withholding tables show that no tax should be withheld. Even if not required, you are encouraged to give the employee a notice about the EITC if his or her 2023 wages are less than $63,698.

If you do not give your employee Copy B of the IRS Form W-2, your notice about the EITC can be any of the following:

  • A substitute Form W-2 with the same EITC information on the back of the employee’s copy that is on Copy C of the IRS Form W-2,
  • Notice 797, Possible Federal Tax Refund Due to the Earned Income Credit (EITC), or
  • Your own written statement with the same wording as Notice 797.

If you give your employee a substitute Form W-2 on time which lacks the required EITC information, you must give notice about the 6IC to the employee within one week of the date you gave him or her the substitute Form W-2. If Form W-2 is required, but not given on time, you must give the employee notice about 2024 EITC by January 31, 2024. If Form W-2 is not required, you must give your notice to the employee by February 10, 2024.

How Do You Make Tax Payments?

When you file your 2023 federal income tax return in 2024, attach Schedule H, Household Employment Taxes. Use this Schedule, discussed further below, to figure your household employment taxes. You will add the federal employment taxes on the wages you pay to your household employee in 2023, less any advance earned income credit payments you make to the employee, to your income tax. The amount you owe with your return is due to the IRS by April 15, 2024.

You can avoid owing tax with your return if you pay enough federal income tax before you file to cover the employment taxes for your household employee, as well as your income tax. If you are employed, you can ask your employer to withhold more federal income tax from your wages in 2023. If you get a pension or annuity, you can ask for more federal income tax withholding from your benefits. Or you can make estimated tax payments for 2023 to the IRS, or increase your payments if you already make them.

Asking for More Federal Income Tax Withholding

If you are employed and want more federal income tax withheld from your wages to cover the employment taxes for your household employee, give your employer a new Form W-4, Employee’s Withholding Allowance Certificate.

If you get a pension or annuity and want more federal income tax withheld to cover the employment taxes for your household employee, give the payer a new Form W-4P, Withholding Certificate for Pension or Annuity Payments (or a similar form provided by the payer).

Paying Estimated Tax

If you want to make estimated tax payments to cover the employment taxes for your household employee, get Form 1040-ES, Estimated Tax for Individuals. Use its payment vouchers to make your payments. You can pay all of the employment taxes at once or in installments. If you have already made estimated tax payments for 2023, you can increase your remaining payments to cover the employment taxes. Estimated tax payments for 2023 are due April 18, June 15, September 15, 2023, and January 16, 2024.

Payment Option for Business Employers

If you own a business as a sole proprietor or your home is on a farm operated for profit, you can choose either of two ways to pay the 2023 federal employment taxes for your household employee. You can pay them with your federal income tax as described above, or you can include them with your federal employment tax deposits or other payments for your business or farm employees.

If you pay the employment taxes for your household employee with business or farm employment taxes, you must report them with those taxes on Form 941 or Form 943 and on Form 940 (or 940-EZ).

What Forms Must You File?

You must file certain forms to report your household employee’s wages and the federal employment taxes for the employee if you pay the employee:

  1. Social Security and Medicare wages,
  2. FUTA wages, or
  3. Wages from which you withhold federal income tax.

The employment tax forms and instructions you need for 2023 will be sent to you automatically in January 2024 if you reported employment taxes for 2023 on Schedule H (Form 1040), Household Employment Taxes.

Employer Identification Number (EIN)

You must include your employer identification number (EIN) on the forms you file for your household employee. An EIN is a 9-digit number issued by the IRS and is not the same as a Social Security number.

You ordinarily will have an EIN if you previously paid taxes for employees, either as a household employer or in a business you own as a sole proprietor, or if you have a Keogh Plan. If you already have an EIN, use that number. If you do not have an EIN, get Form SS-4, Application for Employer Identification Number. The instructions for Form SS-4 explain how you can get an EIN immediately by telephone or in about four weeks if you apply by mail.

Form W-2

A separate 2023 Form W-2, Wage and Tax Statement, must be filed for each household employee to whom you pay:

  • Social Security and Medicare wages of $2,600 or more, or
  • Wages from which you withhold federal income tax.

You must complete Form W-2 and give Copies B, C, and 2 to your employee by January 31, 2023, You must send Copy A of Form W-2 with Form W-3, Transmittal of Wage and Tax Statements, to the Social Security Administration by January 31, 2023.

Schedule H

Use Schedule H (Form 1040), Household Employment Taxes, to report the federal employment taxes for your household employee if you pay the employee:

  1. Social Security and Medicare wages of $2,600 or more in 2023,
  2. FUTA wages, or
  3. Wages from which you withhold federal income tax.

File Schedule H with your 2023 federal income tax return by April 15, 2024. If you get an extension to file your return, the extension will also apply to your Schedule H.

If you are not required to file a 2023 tax return, you must file Schedule H by itself. See the Schedule H instructions for details.

Business Employment Tax Returns

Do not use Schedule H (Form 1040) if you choose to pay the employment taxes for your household employee with business or farm employment taxes. Instead, include the Social Security, Medicare, and withheld federal income taxes for the employee on the Forms 941, Employer’s Quarterly Federal Tax Return, that you file for your business or on Form 943, Employer’s Annual Tax Return for Agricultural Employees, that you file for your farm. Include the FUTA tax for the employee on your Form 940 (or 940-EZ), Employer’s Annual Federal Unemployment (FUTA) Tax Return.

If you report the employment taxes for your household employee on Form 941 or Form 943, file Form W-2 for the employee with the Forms W-2 and Form W-3 for your business or farm employees.

What Records Must You Keep?

Keep your copies of Schedule H or other employment tax forms you file and related Forms W-2, W-3, W-4, and W-5. You must also keep records to support the information you enter on the forms you file. If you are required to file Form W-2, you will need to keep a record of your employee’s name, address, and Social Security number.

Wage and Tax Records

On each payday you should record the date and amounts of:

  • Your employee’s cash and non-cash wages,
  • Any employee Social Security tax you withhold or agree to pay for your employee,
  • Any employee Medicare tax you withhold or agree to pay for your employee,
  • Any federal income tax you withhold,
  • Any advance EITC payments you make, and
  • Any state employment taxes you withhold.

Employee’s Social Security Number

You must keep a record of your employee’s name and Social Security number exactly as they appear on his or her Social Security card if you pay the employee:

  • Social Security and Medicare wages, or
  • Wages from which you withhold federal income tax.

You must ask for your employee’s Social Security number no later than the first day on which you pay the wages. You may wish to ask for it when you hire your employee.

An employee who does not have a Social Security number must apply for one on Form SS-5, Application for a Social Security Card. An employee who has lost his or her Social Security card or whose name is not correctly shown on the card should apply for a new card. Employees may get Form SS-5 from any Social Security Administration office or by calling l-800-772-1213.

How Long To Keep Records

Keep your employment tax records for at least four years after the due date of the return on which you report the taxes or the date the taxes were paid, whichever is later.

State Unemployment Tax Agencies

Alabama
Unemployment Office
649 Monroe St.
Montgomery, AL 36131
(866) 234-5382

Alaska
Employment Security Tax
Department of Labor and Workforce Development
PO Box 115509
Juneau, AK 99811-5509
(888) 448-3527

Arizona
Department of Economic Security
Unemployment Insurance Tax
PO Box 6028
Phoenix, AZ 85005-6028
(602) 542-5954

Arkansas
Department of Workforce Services
PO Box 2981
Little Rock, AR 72203-2981
(501) 682-2121
(855) 225-4440

California
Employment Development Department
P.O. Box 826880 – UIPCD, MIC 40
Sacramento, CA 94280-0001
(888) 745-3886

Colorado
Unemployment Insurance Operations
Department of Labor and Employment
PO Box 8789
Denver, CO 80201-8789
(800) 480-8299

Connecticut
Connecticut Department of Labor
200 Folly Brook Blvd.
Wethersfield, CT 06109-1114
(860) 263-6550

Delaware
Division of Unemployment Insurance
Department of Labor
4425 North Market Street
Wilmington, DE 19802
(302) 761-8446

District of Columbia
Department of Employment Services
Office of Unemployment Compensation Tax Division
4058 Minnesota Ave NE Floor 4
Washington, DC 20019
(202) 698-4817

Florida
Unemployment Compensation Services
Agency for Workforce Innovation
107 E. Madison Street
Caldwell Building
Tallahassee, FL 32399-4120
(850) 245-7105

Georgia
Department of Labor
148 Andrew Young International Blvd.
Atlanta, GA 30303
(404) 232-3301 (direct line for employer tax liability)

Hawaii
Department of Labor and Industrial Relations
830 Punchbowl Street, Rm. 437
Honolulu, HI 96813
(808) 586-8915

Idaho
Department of Employment
317 Main Street
Boise, ID 83735
(800) 448-2977

Illinois
Department of Employment Security
33 South State Street
Chicago, IL 60603
(800) 247-4984

Indiana
Department of Workforce Development
10 North Senate Avenue
Indiana Government Center South
Indianapolis, IN 46204
(800) 437-9136

Iowa
Workforce Development
1000 East Grand Avenue
Des Moines, IA 50319-0209
(515) 281-5387 (Des Moines)
(888) 848-7442

Kansas
Department of Labor
401 SW Topeka Blvd.
Topeka, KS 66603-3182
(785) 296-5027

Kentucky
Division for Employment Services
275 East Main Street
Frankfort, KY 40602
(502) 564-2272

Louisiana
Louisiana Workforce Commission
1001 North 23rd Street
PO Box 94094
Baton Rouge, LA 70804-9094
(225) 342-3111

Maine
Department of Labor
54 State House Station
Augusta, ME 04333
(207) 621-5120

Maryland
Department of Labor, Licensing & Regulation
Division of Labor and Industry
1100 North Eutaw Street, Room 600
Baltimore, MD 21201
(410) 767-2241

Massachusetts
Division of Employment and Training
Charles F. Hurley Building
19 Staniford Street
Boston, MA 02114
(617) 626-6560

Michigan
Unemployment Insurance Agency
3024 W. Grand Boulevard
Detroit, MI 48202-6024
(855) 484-2636

Minnesota
Department of Employment & Economic Development
332 Minnesota Street
Suite E200
St. Paul, MN 55101-1351
(651) 296-6141

Mississippi
Department of Employment Security
1235 Echelon Pkwy
Jackson, MS 39213
(601) 321-6000

Missouri
Division of Employment Security
421 E Dunklin Street
Jefferson City, MO 65101
(573) 751-3215

Montana
Unemployment Insurance Bureau
1327 Lockey Avenue
Helena, MT 59601
(406) 444-3834

Nebraska
Department of Labor
550 South 16th
PO Box 94600
Lincoln, NE 68509-4600
(402) 471-9940

Nevada
Department of Employment Training and Rehabilitation
Employment Security Division
500 East Third Street
Carson City, NV 89713-0030
(775) 486-6310

New Hampshire
Department of Employment Security
45 South Fruit Street
Concord, NH 03301
(603) 228-4100

New Jersey
Department of Labor & Workforce Development
P.O. Box 110
Trenton, NJ 08625-0110
(609) 292-2810

New Mexico
Department of Workforce Solutions
401 Broadway NE
Albuquerque, NM 87102
(877) 664-6984

New York
Department of Labor
WA Harriman State Office Campus
Building 12, Room 356
Liability and Determination Section
Albany, NY 12240
(888) 899-881

North Carolina
Department of Commerce
Employment Security Commission
301 North Wilmington Street
Raleigh, North Carolina 27601-1058
(919) 814-4600

North Dakota
Job Service North Dakota
PO Box 5507
Bismarck, ND 58506-5507
(701) 328-2814

Ohio
Department of Job & Family Services
PO Box 182404
Columbus, OH 43218-2404
(877) 644-6562

Oklahoma
Employment Security Commission
2401 N Lincoln Blvd
Oklahoma City, OK 73105
(405) 557-7100

Oregon
Employment Department
875 Union Street, NE
Salem, OR 97311
(503) 947-1394

Pennsylvania
Department of Labor and Industry
7th and Forster Street
Harrisburg, PA 17120
(866) 403-6163

Puerto Rico
Department of Labor and Human Resources
PO Box 1020
San Juan, PR 00919-1020
(787) 754-5353

Rhode Island
Division of Taxation
One Capitol Hill
Providence, RI 02908
(401) 574-8700

South Carolina
Employment Security Commission
PO Box 995
Columbia, SC 29202-0995
(803) 737-2400

South Dakota
Department of Labor & Regulation
123 W. Missouri Avenue
Pierre, SD 57501-0405
(605) 626-2312

Tennessee
Department of Labor and Workforce Development
220 French Landing Drive
Nashville, TN 37243
(844) 224-5818

Texas
Texas Workforce Commission
101 E 15th St, Rm 122
Austin, TX 78778-0001
(512) 463-2699

Utah
Department of Workforce Services
PO Box 45249
140 East 300 South
Salt Lake City, UT 84145-0249
(801) 526-9235

Vermont
Department of Labor
PO Box 488
5 Green Mountain Drive
Montpelier, VT 05601-0488
(802) 828-4000

Virgin Islands
Department of Labor
2353 Kronprindsens Gade
Charlotte Amalie, St. Thomas, VI 00802
(340) 776-3700

Virginia
Employment Commission
PO Box 1358
703 E. Main Street
Richmond, VA 23219
(866) 832-2363

Washington
Employment Security Department
PO Box 9046
212 Maple Park Ave SE
Olympia, WA 98507
(360) 902-9500

West Virginia
Workforce West Virginia
PO Box 2753
1321 Plaza East Shopping Center
Charleston, WV 25330
(304) 558-0291

Wisconsin
Department of Workforce Development
PO Box 7946
Madison, WI 53707-7946
(608) 266-3131

Wyoming
Unemployment Tax Division
PO Box 2760
100 West Midwest
Casper, WY 82602-2760
(307) 235-3264

Household Employers Checklist

You may need to do the following things when you have a household employee: When you hire a household employee:

  • Find out if the person can legally work in the United States.
  • Find out if you need to pay state taxes.

When you pay your household employee:

  • Withhold Social Security and Medicare taxes.
  • Withhold federal income tax.
  • Make advance payments of the earned income credit.
  • Decide how you will make tax payments.
  • Keep records.

By January 31, 2024:

  • Get an employer identification number, if needed.
  • Give your employee Copies B, C, and 2 of Form W-2, Wage and Tax Statement.

By January 31, 2024:

  • Send Copy A of Form W-2 to the Social Security Administration.

By April 15, 2024:

  • File Schedule H (Form 1040), Household Employment Taxes, with your tax return.

CONTINUE READING
by admin
02 Aug 2024

Becoming a Parent: The Financial Considerations

Once you have a child, financial planning for the future becomes even more essential. How will you finance child care, medical bills, food, education, clothing, toys, and education savings? What will you need to spend money on and how much will each item cost? Here is some of the information you will need.

This Financial Guide provides you with guidelines on handling the expenses a child brings. We cannot offer specific costs because the costs hinge on family size, family income, and geographic location. However, we can suggest some rough (often very rough) estimates for the average-sized family of two adults and two children and provide a starting point for your planning. The costs for later years will go up as inflation takes its toll.

Knowing what to expect will allow you to plan for the future, thereby increasing your chances that you will not fall short of your financial goals. Indeed, this is the time to review and update, if necessary, your financial plan.

Related Guide: Please see the Financial Guide: YOUR FINANCIAL PLAN: Getting Started On A Secure Future.

  • What Will It Cost You
  • Birth Through Infancy
  • Ages One Through Six
  • Ages Six Through Twelve
  • Ages Thirteen Through Eighteen
  • Teaching Your Kids How to Handle Money
  • Savings and Investment
  • Taxes and Credit
What Will It Cost You

Here is a breakdown of the items you’ll need and an estimate of their cost. The costs are categorized chronologically, according to the child’s age.

These estimates are for a first child. Bear in mind that second or third children will cost less than the first since you will already have purchased many of the items you need. If you have three or more children, you will spend about 22 percent less on each child. Also, note that with multiple births, expenses will be higher than (although not double) those of a single birth.

Government estimates say that a middle-income family in 2015, defined as having an annual income between $59,350 and $107,400, will spend a total of $233,610 on raising a child to age 17. This figure represents a 3.0 percent increase from the four years 2010-2014 to the four years 2011 to 2015 and does not include expenses incurred beyond 18. If you include the cost of college, whether public or private, that cost goes up significantly. And, families that earn more generally can expect to spend more on their children.

Planning Aid: For an estimate of the amount of money you would have at the time your child enters college if you begin saving now, see the Financial Calculator: The College Savings Plan Calculator.

Related Guide: If you are ready to start planning now for your child’s future college education-and indeed the time to start is now-please see the Financial Guide: YOUR CHILD’S COLLEGE EDUCATION – How To Finance It.

Birth Through Infancy

Here are the costs you can expect up to birth and during the first year:

For a second or third child, you will spend much less on furniture, clothing, and toys, but health care, child care, and food will remain the same.

Hospital Costs

According to Fair Health, in 2018, an uneventful hospital delivery in the United States costs, on average, $12,290 for a vaginal birth and $16,907 for a cesarean section (C-section) birth. Of course, the actual costs you pay vary depending on your health care coverage and whether there are complications.

Baby Supplies and Equipment

Before you bring the baby home, you’ll buy a crib, a changing table, and a swing or bouncy seat. The moderately priced versions of these three things will cost you about $1,200. You can also expect to pay about $400 for a stroller. A full-size infant car seat will cost you about $150-$200, and a full-size high chair will cost $150. Finally, you will spend several hundred dollars on washcloths, sheets, blankets, towels, undershirts, onesies, and other baby clothes. Also, think about whether you plan to use a diaper service, cloth diapers, or use disposable ones.

Feeding and Diapers

The American Academy of Pediatrics recommends exclusively breastfeeding your baby for at least six months. Many women, of course, choose to breastfeed longer than that. Nursing mothers will have to invest in several good nursing bras and nursing pads (about $50) as well as a nursing pillow (about $25). If you plan to return to work after three months, consider investing in a hospital-grade breast pump, which will run you about $400. In comparison, a year’s worth of ready-mix powder formula costs about $1,350. If you buy the ready-to-serve type of formula, the cost is, even more, running well over $2,000. You’ll also need a year’s supply of bottles, at about $90, and you’ll have to add another $40 to replace the nipples at least twice a year.

When your baby is ready for solid foods, you will also need to account for the cost of rice cereal and baby food.

Diapers are another expense you need to consider. Cloth diapers are the least expensive option. Disposable diaper costs for the first two years run about $850 per year, on average, and a diaper genie costs about $40.

Child Care

Child care expenses vary widely. Childcare in a daycare center costs much less than a live-in nanny (unless you have multiples, then a nanny or au pair is the less expensive option), and prices for daycare centers vary widely. Childcare in a daycare center costs much less than a live-in nanny. A mid-priced daycare center can cost families close to $20,000 per year or more.

Health Care

Your infant will visit the doctor about six times during his or her first year, including well-baby check-ups as well as the inevitable colds and fevers of infancy. How much you will spend on doctor visits during the first year depends on your health insurance.

Toys and Clothes

You will spend about $500-$600 on toys and clothing during the first year (in addition to what you bought for the layette.)

Total for the First Year

Your total expenses for the first year run about $15,000-$18,000. The biggest variable is the cost of health care.

Ages One Through Six

During these years, you’ll spend about $1,000 on toys and clothes and about $2,200 a year on food. If your child attends daycare or preschool, add in the cost of these services. In most locations, daycare will cost you close to $20,000 per year – or more, while preschool costs vary widely. Again, health care costs depend on your health coverage.

Ages Six Through Twelve

This is when the overall expenses of child-rearing drop and families can save more. During these years, your child care expenses will drop drastically. Health care costs generally stabilize unless, of course, your child begins orthodontia during this stage. Then, you’ll have to pay more. You are likely to spend more than in the previous stage on clothing, toys, and entertainment, but your kids won’t be demanding the high-ticket clothing and other items of adolescence. The bill for food will be just slightly more than what it was in the previous stage. On the negative side, now that your kids are in school, you’ll want to pay for all those extras that middle-class kids have: dancing and music lessons, sports participation, and so on. And, if you decide to send your kids to private school or summer camp, these expenses will have to be considered as well.

Ages Thirteen Through Eighteen

During this stage, you can expect your child’s food, clothing, and entertainment bill to exceed what it was during the previous stage. For instance, food costs will increase as a result of growth spurts in your adolescent and clothing costs are likely to rise as well as your teen takes more of an interest in his or her appearance.

Once your teen starts driving, your auto insurance will go up. The extra cost could be anywhere from $300 to $1,000. Factors affecting these costs typically depend on your state of residence and whether your child is a male or female. If you intend to buy your child a car, add this expense in as well.

Sweet-16 parties, quinceaños, bar and bat mitzvahs, orthodontia, SATs, ACTs and preparation courses, music lessons, sports, and college application fees are just some of the things you might be paying for during those years.

Teaching Your Kids How to Handle Money

The best time to start instilling financial skills and values is when children are young. Start giving your kids an allowance once they reach school age. Let them participate in deciding how much their allowance should be.

Some parents may want to require kids to do household chores to earn the allowance. Parents might want to provide an allowance but pay kids extra for the performance of tasks. This incentive plan is, of course, a matter of individual child-rearing philosophy, but it does get the message across that money does not grow on trees.

Give your kids control over their own money (their allowance and whatever monies you give them that are not earmarked for some particular purpose). You can make suggestions to them about what they should do with it-i.e., that they might spend half and save half but allow them the final say on what happens to the money.

Let them see the consequences of both wise and foolish behavior with regard to money. A child who spends all of his money on the first day of the week is more likely to learn about budgeting if he is not provided with extras to tide him over.

How much allowance to provide is a matter of parental discretion. Most parents provide about $7 per week to their elementary school children and from $12 to $20 a week to kids in junior high.

Savings and Investment

Beyond the basics of budgeting and saving, you will want to get your child involved in saving and investing. The easiest way to do this is to have the child open his or her own passbook savings account.

If you want your child to get familiar with investing, there are various child-friendly mutual funds available. The mailings from the fund can be a source of education. Or you may want to get the child interested in individual stocks.

You may want to start a “matching” program with your kids to encourage saving. For instance, for every dollar that the child puts into a savings account or investment, you might match it with 50 cents.

If you want to get your kids involved with investing, you will need to set up a custodial account. There are two types of widely used custodial accounts – the Uniform Gifts to Minors Act and the Uniform Transfers to Minors Act. The type of custodial account available depends on which state you live in.

With a custodial account, the child is the owner; however, the custodian (usually a parent) manages the property until the child reaches the age of majority under relevant state law, either 18 or 21. The custodian must follow certain rules concerning the management of the funds in the account to ensure that the custodian does what is in the child’s best interests.

IRAs for Kids

If your child has earned income from a paper route or babysitting, for example, or working in the family business, he or she can contribute earnings to an IRA. The IRA can be an extremely effective investment for a child because of the IRA’s tax-deferral feature and the length of time the money remains in the IRA. A $3,000 contribution per year to the child’s IRA for ten years could reach $600,000 or more if the money is left to grow until the child reaches age 65 – depending on the returns on the investment.

In 2023, your child can contribute $6,500 or the lesser of his or her earned income for that tax year to a traditional IRA or a tax-free Roth IRA. The contribution limits are the same for both types of accounts.

To replace the “lost” earnings, the parents can give $3,000 per year to the child (or the amount of earned income the child has, if less). The child may have to file tax returns.

The drawback, of course, is that, with some exceptions, the money in an IRA (including a Roth IRA) account cannot be withdrawn before age 59-1/2 may be subject to additional taxes and penalties – unless certain exceptions are met such as withdrawals to pay for qualified education expenses or pay for unreimbursed medical expenses or health insurance premiums if the account holder is unemployed.

Related Guide: For tax rules on IRA withdrawals for higher education, please see the Financial Guide: HIGHER EDUCATION COSTS: How To Get The Best Tax Treatment.

Taxes and Credit

Kids can learn to use automatic teller machine cards for their savings accounts. They can also start using credit cards at an early age-with parental counsel and involvement. They can learn the concepts of incurring and paying off debts both from credit card use and from small loans that parents make them.

It is important to familiarize kids with paying taxes as well. If children have to file tax returns-as they would with an IRA – allow them to participate in the process; this will get them used to the idea of yearly tax payments, and can also be an opportunity for learning about how governments are run with tax revenues.

One side benefit of getting your kids involved in money management is that it may help to avoid the “math phobia” some kids experience in junior high school.

Professional guidance should be considered for a life event change as major as a marriage of divorce.

Source: Expenditures on Children By Families 2015, US Department of Agriculture Publication Number 1528-2015. Before-tax Income of $59,200 and $107,400 (Average = $83,300).

Child’s Age Misc. Housing Food Transport Clothing Health Care Child Care & Education Total
Up to 2 $830 $3,680 $1,580 $1,790 $750 $1,180 $2,870 $12,680
3-5 $940 $3,680 $1,690 $1,840 $600 $1,110 $2,870 $12,730
6-8 $1,050 $3,680 $2,280 $1,900 $600 $1,130 $1,710 $12,350
9-11 $1,110 $3,680 $2,680 $1,940 $780 $1,280 $1,710 $13,180
12-14 $950 $3,680 $2,780 $2,090 $860 $1,240 $1,430 $13,030
15-17 $940 $3,680 $2,790 $2,270 $830 $1,300 $2,090 $13,900
Total $17,460 $66,240 $41,400 $35,490 $13,260 $21,270 $38,040 $233,610

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by admin
01 Aug 2024

Life Insurance: How Much and What Kind To Buy

How much life insurance do you need? What type is appropriate? You should review your life insurance needs each time you have a major life event. Here is what you need to know to properly plan for your life insurance needs to buy enough and to get the most for your money.

The prospect of planning for your family’s life insurance needs may seem daunting. The array of confusing products available, coupled with the calculations needed to find the right amount of insurance, would put anyone off.

Yet the hard fact is that life insurance is an essential part of your family’s financial well-being. The more you know about it before you go to your agent, the better your coverage will be. If you don’t plan for your life insurance needs, the result could be a waste of thousands of dollars on inappropriate or ineffective life insurance or, worse, financial hardship due to not having enough insurance.

This Financial Guide gives you some basic guidelines about whether and when you should purchase life insurance, and provides you with a system for determining how much you need. It also discusses the types of insurance available, their suitability for various situations, and how to comparison shop for a policy.

  • Do You Need Life Insurance?
  • How Much Life Insurance Do You Need?
  • Types Of Insurance
  • How Insurance Products Differ
  • How To Shop For Insurance
  • Shopping For A Policy
Do You Need Life Insurance?

The purpose of life insurance is to provide a source of income, in the case of your death, for your children, dependents, or other beneficiaries. Life insurance can also serve other estate planning purposes, such as giving money to charity on your death, paying for estate taxes, or providing for a buy-out of a business interest. These will not be discussed in this guide, however.

Related Guide: Please see the Financial Guide: ESTATE PLANNING: How To Get Started.

Whether you need to buy life insurance depends on whether anyone is depending on your income. If you have a spouse, child, parent, or some other individual who depends on your income, you probably need life insurance. You might also need life insurance for estate planning or business succession planning purposes.

Here are some typical insurance situations along with typical insurance needs:

Situation 1: Families or single parents with young children or other dependents

The younger your children, the more insurance you need. If both spouses earn income, then both spouses should be insured, with insurance amounts proportionate to salary amounts. If the family cannot afford to insure both wage earners, the primary wage earner should be insured first, and the secondary wage earner should be insured later on. A less expensive term policy might be used to fill an insurance gap. If one spouse does not work outside the home, insurance should be purchased to cover the absence of the services being provided by that spouse such as child care, housekeeping, and bookkeeping. However, if funds are limited, insurance on the non-wage earner should be secondary to insurance on the life of the wage earner.

Situation 2: Adults with no children or other dependents

If your spouse could live comfortably without your income, then you will need less insurance than the people in Situation (1). However, you will still need some life insurance. At a minimum, you will want to provide for burial expenses, for paying off whatever debts you have incurred, and for providing an orderly transition for the surviving spouse. If your spouse would undergo financial hardship without your income, or if you do not have adequate savings, you may need to purchase more insurance. The amount will depend on your salary level and that of your spouse, on the amount of savings you have, and on the amount of debt you both have.

Situation 3: Single adults with no dependents

You will need only enough insurance to cover burial expenses and debts unless you want to use insurance for estate planning purposes.

Situation 4: Children

Children generally need only enough life insurance to pay burial expenses and medical debts. In some cases, a life insurance policy might be used as a long-term savings vehicle.

Situation 5: Retirees

There is less of a need for life insurance after retirement unless it is to be used for other estate planning purposes. You may need to provide an income for the second spouse to die if your retirement assets are not large enough. Further, you will need some insurance to pay burial expenses, final medical costs, and debts.

How Much Life Insurance Do You Need?

Determining how much insurance to buy requires you to invest some time in calculating:

  • Your current annual household expenses
  • Your assets, debts, and other sources of income.

We’ve provided a worksheet, which we will refer to in our discussion.

Find out how much insurance you need before considering which type of insurance to buy. Having enough is more important than having the right type. You should provide for your insurance needs immediately, although you can always switch to a more cost-effective or investment-oriented type of insurance later.

The ideal amount of coverage is the amount that would allow your dependents to invest the insurance proceeds after your death and maintain their desired standard of living without touching the principal. Although the old rule of thumb to buy five, six or seven times your annual salary may serve as a starting point, it is no substitute for making the calculations to find out how much you really need.

By using the worksheet and our explanations, you will be able to make a fairly good estimate of your insurance coverage needs. You will need to make some assumptions about your family’s future.  It’s important to be as accurate as possible in filling out the worksheet since an underestimation could lead to your being underinsured, and an overestimation will lead to money wasted on unnecessary coverage.

Here is a line-by-line discussion of how to prepare the worksheet.

Line 1: Calculate The “Annual Income Needed”

Line 1 of the worksheet, “Annual Income Needed,” is the amount that your survivors would need to live comfortably. It is important not to underestimate this amount. If there are recurring expenses that your family incurs but that are not shown on the list below, do not neglect to include these.

To arrive at the “Annual Income Needed,” find the following amounts paid monthly. Then multiply the figure you arrive at by 12 to arrive at an annual amount. Add the following amounts:

Mortgage or rent, and other home-related expenses. Include your monthly mortgage payment, with insurance and real estate taxes, or the amount paid for rent. Also include the amounts you spend monthly on home repairs-e.g., plumbers, contractors, electricians, appliance repair-and on home improvements. Add to this the amounts spent monthly on furniture, appliances, linens, and other items bought for the home $___________
Heat, electricity, insurance (life, health, and liability) water, gas, trash collection, and other monthly bills $___________
Food, including other items bought at grocery stores or drug stores, such as toothpaste, and including restaurant bills $___________
Clothing $___________
Travel, including car payments, gas and oil, car repair, and car payments $___________
Child care or other dependent care $___________
Recreation, including travel, gifts, theater, cinema $___________
Other $___________
Total $___________
Multiply by 12 and enter amount in Line 1 of the worksheet (below) $___________

Line 2: Subtract “Other Sources”

The next item on the worksheet represents the income that your survivors will have. If there are sources of income other than the ones listed, do not neglect to include them.

To calculate Social Security benefits, you may wish to obtain an estimate of your benefit from the Social Security Administration. You can obtain a request form by calling SSA’s toll-free number-800-772-1213.

Since you cannot predict the amount your survivors will receive (it will depend on your age at death, your earnings, and the ages of your children), you may use the following as rough estimates: $4,000 per year if you have one child under 16, or $5,000 for two or more children under 16.

Do not include other insurance proceeds here; this will be accounted for later.

Line 3: Determine The “Shortfall”

Line 3 represents the shortfall, i.e., the amount you need your insurance proceeds to replace. This is determined by subtracting the “Annual Income From Other Sources” amount from the “Annual Income Needed.”

Line 4: Determine the “Amount Of Proceeds Needed”

Line 4 is the amount that will generate the investment income needed to make up the annual “Shortfall” in Line 3.

The amount by which you should divide line represents the after-tax rate of return you can expect on the invested life insurance proceeds. The amount you choose to divide by depends on how conservative you want to be. It is reasonable for most people to expect an after-tax rate of return of at least six percent. But if you want to ensure that you are protected from inflation risk and interest rate risk, use the lower divisor of four percent. The middle divisor of 5 percent represents a “middle of the road” approach.

The amount you arrive at is the amount of death benefit (proceeds) you will need. The amount will be further adjusted as you work through the worksheet.

Line 5: Add the “Lump-Sum Expenses”

These are the items your family will have to pay for at the time of death. They differ from the “annual income needs” amounts in that they are not part of the family’s everyday living expenses. Further, unlike the annual income amounts, they represent pure guesswork. If you wish to strive for a higher rate of accuracy, you can try to adjust these items for inflation, but this is not strictly necessary.

The estimate for funeral expenses should be at least $5,000. Depending on your desires and those of your family, you can adjust this figure upward.

The final medical expenses will be minimal if you have adequate health insurance. You can estimate this amount by finding out how much your policy requires you to contribute per illness.

The estate administration and probate costs can be estimated at 5 percent of your estate for the sake of simplicity. Your estate is the total value of your assets at death.

You will only owe federal estate taxes if your taxable estate exceeds the amount of the unified credit exemption equivalent. Your state inheritance taxes will depend on the laws in your state.

The “emergency living expenses” amount can range from three to six months’ worth of family living expenses.

The “debts” amount represents debts that your family desires to pay off at your death. Normally, it does not include items that make up the “annual living expenses” such as mortgage payments, car payments. However, if you decide that you wish to use insurance proceeds to pay off such expenses, then add in the amounts you estimate will be needed to pay off such debts.

As for future education expenses, it is suggested that you use an annual cost of $20,000 per child, per year, for the sake of simplicity.

Line 6: Determine the “Interim Insurance Proceeds Amount”

Subtract the “future expenses” on line 5 from the “proceeds needed” amount on line 4. This is the amount of insurance you will need to buy on your life. The amount will be further adjusted.

Line 7: Subtract the “Assets That Can Be Sold and Other Insurance”

For line 7, determine the amounts that represent assets that your survivors could liquidate to pay future expenses. Do not include any assets your survivors will be using to produce income that you included in “other sources.” Also, note that you should include insurance payments and pension death benefits here, and not on the line for “other sources.” This is because such proceeds will represent one-time payments and not sources of annual income.

Line 8: Determine the “Total Insurance Needed”

Subtract the “assets that can be sold and other insurance” on line 7 from the interim insurance proceeds amount” on line 6. This is an estimate of the amount of insurance coverage you need.

Life Insurance Worksheet

ITEM

YOUR ESTIMATE
1. Annual income needed. $_____________
2. Subtract other annual income sources:
    Salary of surviving spouse and other family $_____________
    Estimated earnings on investments $_____________
    Social Security $_____________
    Pension income $_____________
    Other income $_____________
Total other annual income sources $_____________
3. Subtract total of line 2 items from line 1 $_____________
4. Amount of proceeds needed (divide line 3 by 4%, 5%, or 6%) $_____________
5. Lump-sum expenses:
    Funeral expenses $_____________
    Final medical costs $_____________
    Estate administration and probate costs $_____________
    Federal estate and state inheritance tax $_____________
    Emergency living expenses fund $_____________
    Debts to be paid off $_____________
    Education expenses $_____________
    Other lump-sum expenses $_____________

Total lump-sum expenses:

 $_____________
6. Interim insurance proceeds needed
(add line 4 and total of line 5 items)		 $_____________
7. Assets that can be sold and other insurance
    Employer-provided group life insurance $_____________
    Other life insurance. $_____________
    Death benefit from pension plan. $_____________
    Cash, savings. $_____________
    IRA, Keogh, and 401(K) plan lump sum amounts $_____________
    Other assets that can be sold $_____________

Total assets

 $_____________
8. Total insurance needed (subtract total of line 7 items from line) $_____________

Types Of Insurance

Although the array of insurance products may seem confusing, there are really just two types of insurance: term and cash value, which is more commonly referred to as whole life, universal life, or permanent life insurance.

With term insurance, you pay for coverage for a specified amount of time, and if you die during that time the insurer pays your survivors the death benefit specified. Cash value on the other hand provides you with some other redeemable value in addition to paying a death benefit. For individuals age 40 or less, a term policy will almost always be less costly than a whole life policy. Although term policies do not build cash values, many are convertible to whole life policies without a physical exam. Thus, a term convertible policy may be a good option for someone who is under 40.

Term Insurance

There are various types of term insurance including:

Renewable. A renewable term policy is the most common type of life insurance where the policy renews automatically on a renewable term, e.g. every year, every 5 years, every 10 years, or every 20 years, which is the most popular renewal term. You do not need to take a physical or verify the fact that you are employed. The premium goes up at the beginning of each new term to reflect the fact that you are older. Most renewable term policies can be renewable until you reach age 70 or so.

Re-entry. With this type of policy, you must undergo a physical exam after a certain period, or pay an extra premium.

Level. With level term policies, the premium is guaranteed to stay the same over a certain period. This period may be shorter than the term of the policy. Nearly all life insurance bought today is level term insurance.

Decreasing. With a decreasing term policy, a good option for insuring mortgage payments the face amount of the policy decreases over time while the premium payments remain the same.

Return of Premium. Some insurers offer term life with “return of premium.” Typically, premiums are significantly higher and they require keeping the policy in force to its term.

Cash Value Life Insurance

There are four types of cash value life insurance: (1) whole life, (2) universal life, (3) variable universal life and (4) variable whole life. The first two types are the most common and have a guaranteed cash surrender value; in the last two types, the cash surrender value is not guaranteed.

Whole Life. This is the traditional life insurance policy. It provides a death benefit, has a cash value build-up, and sometimes pays dividends. You do not need to renew a whole life policy. As long as you pay your premiums, you will have coverage, usually until your death. The premium for a whole life policy remains the same for the amount of time you own the policy; the premium is “level” in insurance parlance. Thus, when you are younger, the premium you pay for whole life will be greater than what you would pay for term insurance but when you are older, the premium will be much less than a term premium. Part of each premium goes into the cash value of your policy. Your cash value, which is actually an investment, is guaranteed to grow at a fixed rate. You do not have to pay current income taxes on the growth in the cash value-it is tax-deferred.

You can borrow against your cash value at a rate that is usually better than the prevailing consumer lending rates. If you die with an outstanding loan amount, the loan amount, plus interest, will be subtracted from your death benefit.

Dividend-paying whole life policies-termed “participating” policies are usually offered by mutual life insurance companies. Mutual life insurance companies are generally owned by policyholders while other insurance companies are owned by shareholders. The dividends are refunds of insurance premiums that exceed a certain level. They are paid when the insurance company does well during a quarter or a year. Of course, premiums for participating policies are usually higher than those paid for non-participating policies.

Term policies can also be participating, but the dividends paid are usually minimal.

Universal Life. Universal life, also known as “flexible premium adjustable life,” is similar to whole life, but offers more flexibility in terms of payment of premiums and cash value growth. With a universal life policy, your monthly premium amount is first credited to your cash value. The company then deducts the cost of your death benefit and the expenses of the policy. These costs are about equal to what it would cost to buy term coverage. As with whole life, your cash value grows at a fixed minimum rate of interest. The growth of the cash value is tax-deferred, and you can borrow against it or make partial withdrawals.

A special feature of universal life is that you can vary the premium paid from month to month. You can pay more or less-within certain limits-without jeopardizing your coverage. You can even let the cash value absorb the premium. However, the danger here is that if the premium payments fall too low, your policy may lapse. While some states require the insurer to tell you when your cash value is at a dangerously low point, you will, if you live in another state, have to maintain a careful watch on the amount of cash value if premiums are skipped.

Variable Universal Life. Variable universal life allows you to choose the investment for your cash value. You have a potentially greater cash value growth, but you also have added risk, depending on the type of investment you choose.

Variable Whole Life. With variable whole life, the death benefit and cash value will depend on the performance of an investment fund that you choose. Again, you have potentially greater reward, with its accompanying risks.

How Insurance Products Differ

Here, in table form, is a summary of the different features of the various types of life insurance.

Term Life Universal Life Whole Life Variable Whole Life Variable Universal Life
Policy term Stated in policy Until age 95 Life Life Life
Type of death benefit Determined Variable Determined Variable Variable and determined
Existence of cash value No Current rate, guaranteed minimum Fixed rate, guaranteed Variable rate, not guaranteed Variable rate, not guaranteed
Ability to choose cash value investments N/A No No Yes Yes
Regulatory agency Insurance Insurance Insurance Insurance and securities Insurance and securities

How To Shop For Insurance

In order to be able to shop for the best premiums, it’s a good idea to know how premiums are calculated by insurers. Bear in mind that premiums vary among insurance companies, and it is a good idea to ask several insurers for their rates.

Insurance companies place individuals into four risk groups: preferred, standard, substandard, or uninsurable. The premiums charged will be commensurate with the category you are placed in. Thus, a standard risk will pay an average premium for similarly situated insurers.

If you have a high-risk job or hobby, you will be considered substandard, a high risk. A terminal illness at the time you apply for insurance will render you uninsurable. Having some type of chronic illness will place you in the substandard category. People with conditions such as diabetes or heart disease can be insured, but will pay higher premiums.

One company’s category for you may not hold with another company. Thus, it still pays to shop for insurance with other companies even though one may have labeled you “substandard.”

Once an insurance company approves you for coverage, you cannot be dropped unless you stop paying your premium.

Shopping For A Policy

In most states, there are rules, set by a group of state insurance regulators, requiring the agent to calculate two types of cost indexes that can help you to shop for a policy. You can use the indexes to compare policy costs.

One type of index, the net payment index, gauges the cost of carrying your policy for the next ten or twenty years. The lower the number is the less expensive the policy will be. This index is useful if you are most interested in the death benefit aspect of a policy, as opposed to the investment aspect. The other type of index, the surrender cost index, is useful to those who have a high level of concern about the cash value. This index may be a negative number. The lower the number, the less expensive the policy.

These two indexes apply to term and whole life policies. With universal life policies, focus on the cash value growth and the cash surrender value to make comparisons. Cash surrender value is the amount you receive if you cancel the policy. It is not the same as cash accumulation value. If you are shown two universal life policies, and they have the same premium, death benefit, and interest rate, then the one with the higher cash surrender value is generally the better policy.

Here are some questions to ask about policies:

  • How do cash values accumulate? An early, rapid build-up is generally preferable.
  • How has the policy’s cash value performed in the past? You can get this information from a publication called Best’s Review, Life and Health Insurance edition. Determine how the policy performed in comparison with the company’s projection and with other insurers.
  • Are any special features merely bells and whistles, or do they add value for you?
  • What is the company’s rating with Best, Standard & Poor’s, and Moody’s? You can find these publications in public libraries. The rankings should be in the top three to ensure that a company has financial stability.

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