In this week’s “Money Talks” Case Study, we discussed a couple, ages 42 and 49 with two kids near college age, at 16 and 17. Next thing they know…oops baby is on the way! While they are happy with the news, this fundamentally changes their financial plan.
Together, they make $197,000 gross. She is the primary breadwinner, earning $130,000 while he earns $49,000. She also has a freelance consulting business that brings in $18,000. However, with two jobs and a new baby, it’s very likely her freelance income will be going away.
So, we have a couple who was closer to the empty-nest phase with their children and now they find themselves in a situation where income and savings will be decreasing and spending increasing because of the new child on the way. Their time horizons will need to change unless they are able to make a change to their lifestyle. Let’s look at their situation and ask, “what can we do to manage cash flow?”
From a tax standpoint, they will be able to add a dependency exemption for the new baby. While the dependency exemptions are phased out for higher income levels—$305,050 in adjusted gross income for married filing jointly—this couple does not have to worry about that.
However, one advantage they may be able to consider is the Dependent Care Flexible Spending Account through their employer. This allows a parent to set aside up to $5,000 pretax for dependent care, such as nannies, daycare or certain after-school programs. At the 25% tax bracket, this could save the couple $1,250 in federal taxes.
Additionally, with one child nearing college, we recommend they look into the American Opportunity Tax Credit (AOTC) for higher education expenses, such as the cost of tuition, fees and course materials paid during the tax year.
The AOTC is available the first four years of college and is a tax credit of 100% of the first $2,000 in qualified expenses, and then 25% of the next $2,000 of expenses. The tax credit reduces the amount of tax this couple will owe, dollar for dollar, by the amount of the AOTC for which they qualify. However, this credit phases out between $160,000 and $180,000 for married filing jointly in 2014. Because they contribute to their 401(k)s pretax, their current AGI is around $181,000. At this level they are ineligible for the tax credit. However, once their freelance income disappears, this brings them to an AGI around $163,000. If this couple were able to free up some money and increase their 401(k) contributions, they could potentially lower their AGI enough to take full advantage of the tax credit.
This couple finds themselves in the unique situation where they should save more for retirement to maximize tax savings opportunities. In this case, increased retirement savings could positively affect their tax situation and stretch their college savings further.
If you have questions regarding how augmenting your cash flow may save you more in your overall financial plan, experts at Henssler Financial will be glad to help:
- Experts Request Form
- Email: experts@henssler.com
- Phone: 770-429-9166.
Disclosures
This article is meant to provide valuable background information on particular investments, NOT a recommendation to buy. The investments referenced within this article may currently be traded by Henssler Financial. All material presented is compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. The contents are intended for general information purposes only. Information provided should not be the sole basis in making any decisions and is not intended to replace the advice of a qualified professional, such as a tax consultant, insurance adviser or attorney. Although this material is designed to provide accurate and authoritative information with respect to the subject matter, it may not apply in all situations. Readers are urged to consult with their adviser concerning specific situations and questions. This is not to be construed as an offer to buy or sell any financial instruments. It is not our intention to state, indicate or imply in any manner that current or past results are indicative of future profitability or expectations. As with all investments, there are associated inherent risks. Please obtain and review all financial material carefully before investing. Henssler is not licensed to offer or sell insurance products, and this overview is not to be construed as an offer to purchase any insurance products.
