Financial planning for new parents

What you'll learn

• How a new arrival affects your family finances
• How to come up with a financial plan for your family
• How to save in a tax-efficient way

So just how much money do you need to raise a child? According to insurer LV=, which produces an annual ‘Cost of a Child’ report, parents with babies born in 2016 will spend an average of £231,843 on their children up to the age of 21, a figure that’s risen by nearly £2,500 since 2015.

The three biggest items of expenditure are education, (this includes university tuition fees but not private school fees), childcare and food, which cost an average of £74,430, £70,466 and £19,004 respectively from birth, until the age of 21.

Making and sticking to a financial plan

When you find out you’re expecting, your focus is likely to be on getting your home ready for a new baby but you’ll need to make time to put your financial house in order too. A good starting point is to draw up a budget and make a list of all your current incomings and outgoings.

The list should include all regular, fixed costs such as your mortgage or rent, insurance, council tax, utility/phone bills and so on. Remember to include items that crop up only once or twice a year, such as your TV licence, car MOT and servicing, as well as holidays. With these figures in front of you, consider whether you could cut back on and then divert the extra cash into a savings fund.

Whether starting to save or increasing existing savings, it would be wise to include an emergency fund to cover any unexpected events such as illness or even redundancy. Financial advisers typically suggest that you should have enough savings available to cover household costs for six months.

Prepare for a drop in income

If you and your partner both work, maternity or paternity leave typically means a reduced income while either parent is off work.

Find out what your employer offers, and what state support you might be eligible for, so you know how much you'll have to survive on while you aren’t working and can budget accordingly.

Building up a savings pot

Parents-to-be often find individual savings accounts (ISAs) a smart way to save up to meet future family expenditure because all gains and returns are sheltered from the taxman. This tax-year you can invest up to £20,000 into your ISAs, with the choice to split your allowance between a cash, investment, innovative finance and a lifetime ISA. However, with a lifetime ISA¹, you can only pay in up to £4,000. Alternatively, you can invest in a combination of these but you can only pay into one cash ISA, one investment ISA, one innovative finance ISA and one lifetime ISA each tax year.

The important thing to remember about investment ISAs is that, unlike cash, investments held can fall in value as well as rise, so you may get back less than you invest.

Returns from cash savings accounts and investment funds which pay interest, such as (unit trusts, open ended investment companies (OEICs) or Eexchange Traded Funds (ETFs,) held inside an ISA are free of income tax. If you hold cash savings or receive interest from funds investments outside an ISA, basic-rate taxpayers are entitled to a Personal Savings Allowance (PSA), which allows them to earn tax-free annual interest of up to £1,000 from bank or building society savings accounts and other investment income. Higher-rate taxpayers will get a £500 allowance but additional rate taxpayers won’t be entitled to any PSA.

If you choose to hold investments inside an ISA, you don’t pay tax on any dividends you receive, nor income tax on interest from bonds and there’s no capital gains tax to pay. Outside an ISA, you can earn up to £2,000 of dividend income tax-free in the 2018-19 tax year. Above these limits, dividends are taxed at 7.5% if you’re a basic rate taxpayer, 32.5% if you’re in the higher bracket and 38.1% if you’re an additional rate taxpayer.

If you invest outside an ISA, total gains made in a tax year which are below the annual Capital Gains Tax (CGT) allowance, which for the 2018-19 tax year is £11,700, are not subject to tax. Only gains in excess of this are taxed at 10% or 20% depending on your tax band. When you invest in an ISA any gains that you make, you won’t be subject to pay CGT.

Bear in mind too that tax rules can change in future and their effects on you will depend on your individual circumstances.

In terms of planning for your child’s future, such as university costs, you could look at saving and/or investing in a junior ISA, which enjoys all the same tax-efficient benefits as its adult counterpart. However, with these accounts the annual contribution allowance is capped at £4,260 (2018-19).

There are two types of Junior ISA: cash accounts where no tax is paid on interest earned, and stocks and shares accounts where no tax is paid on any capital growth or income received. As the name suggests, these invest in stocks and shares but also other investments, which, unlike deposits in cash ISAs can fall in value. Anyone can add money into a Junior ISA on behalf of a child, not just the parents setting it up. What's important is that the total money paid in doesn't exceed the annual allowance.

Be aware that your child can become the registered contact for their Junior ISA account when they turn 16 even though they can't withdraw the money until reaching 18. If left alone until this point, the Junior ISA will automatically convert to an adult ISA. But be warned, you need to be comfortable with the fact that your child, when they get their hands on the cash, may not decide to use the it in the same way that you originally planned at the outset.