If you're expecting a new addition to your family in 2017, then your tax situation can change considerably. Most of the changes are in your favor, such as the child tax credit and an additional personal exemption, but there are a couple of things you should do to make the most of the tax changes that come with having a baby.
Change your withholdings
One of the first things you should do if you're expecting a baby in 2017 is to adjust your withholdings with your employer. Usually, this is simply a matter of contacting your payroll or HR department and requesting the change.
In case you're not sure how many exemptions you should claim, here's a quick guide:
- You can claim one exemption if nobody else can claim you as a dependent.
- You can claim an additional exemption if you're single and only have one job, if you're married with one job and your spouse does not work, or if your wages from a second job (or your spouse's job) are $1,500 or less.
- Another exemption is allowed if you will file as Head of Household in 2017.
- Yet another exemption can be claimed if you will have at least $2,000 worth of child care expenses for which you will claim a tax credit.
- You can claim one exemption for your spouse.
- If you have children or other dependents, claim one exemption for each of them.
- If your total income will be less than $70,000 ($100,000 if married), you can claim two exemptions per child, minus one if you have 2-4 children, and minus two if you have five or more children. If your income will exceed these thresholds but will be less than $84,000 ($119,000 if married), claim one exemption for each child.
For example, if you're married and you and your spouse both work, you have two children, and you expect more than $2,000 worth of child care expenses and qualify for the child tax credit through the lower income limitation, then this would add up to eight exemptions on your W-4, based on the guidelines listed above.
Now, you don't have to claim all of the W-4 exemptions to which you are entitled. Claiming fewer exemptions may result in a bigger tax refund. However, that's not a good thing -- a large tax refund simply means you let the government borrow some of your money interest-free for over a year.
Start a college savings account
It's never too early to start saving for your child's college education. In-state public tuition rates rose at an annual average rate of 3.5% over the past 10 years, and if they continue to do so, this means that tuition could rise by another 86% by the time your newborn is 18 years old.
The good news is that the stock market has historically grown much faster than that, making it a great idea to start investing for your child's education as early as possible. In fact, at the stock market's historical average total return rate, a $5,000 investment now could swell to more than $25,000 by the time your child reaches college age.
529 Savings Plans are run by the states, so there can be big differences among plans regarding state tax incentives and investment choices. A 529 works similarly to a Roth IRA in that contributions are not tax-deductible, but all of your withdrawals for qualifying higher-education expenses are 100% tax-free. 529 plans have high contribution limits and a selection of mutual funds to invest in.
Coverdell ESAs (that's "education savings accounts") are similar in many ways, such as the Roth-like tax structure. These are not run by the states, so you won't get any state tax benefits for them, and contribution limits are much lower at $2,000 per year. However, you aren't restricted to just a few investment options; you can choose any stocks, bonds, or funds you want. And your money isn't restricted to college-related expenses. You can use Coverdell funds for educational expenses at any level, such as for a private high school.
One thing I should mention: This isn't technically a move to make now, but be sure to do it before the end of the year. You'll need the baby's Social Security number to set up an account in their name, which typically doesn't arrive until a few weeks after birth. However, to save you from having to set aside a lot of money all at once, consider gradually saving some money while you're expecting with the intention of contributing it to your child's college savings.