Family financial planning In the BC (Before Children) Years

Introduction

This guide is designed to help aspiring first-time parents with their financial planning. 

It explains why having and raising children can be such a financial challenge, gives details of the biggest financial pain points you will probably go through as a parent, and offers some suggestions for how to manage them. 

Topics covered include: 

• The big picture: the way that starting a family generally causes your outgoings to rise and your income to fall at the same time – something we have called the ‘Concertina Effect’
• Six financial ‘pain points’ to be aware of when starting a family and as your family grows
• Four golden rules for making a Family Financial Plan

Reduced income

It’s not just the cost of feeding and clothing children that has a big impact on the finances of a first-time family, it’s the likely drop in household disposable income as well. You are likely to experience this in two ways:

1. Even with the most generous employer, parental leave is unlikely to offer you full pay for the whole of the first year. For much of that period you could find yourself on a reduced income or even with no income at all. We discuss the rules around pay during parental leave later in this guide.
2. You cannot simply assume your income will go back to where it was once parental leave is up. The logistics of working in exactly the same way as you did before can be difficult. Many parents find that at least one partner has to work part time for a number of years in order to fit work around drop offs and pick-ups of children.

Official figures from the Office for National Statistics show that the most common working arrangement among couples with children is for the father to work full-time and the mother to work part-time until the youngest child is 11.

This chart shows work patterns for mothers by their youngest child’s age (bear in mind that in some cases these women will already have another older child at home, which explains why fewer than might be expected are working full time at the beginning).

The significant rise in costs, together with a drop in income, gives rise to something we have called “the concertina effect” – a double hit on parental living standards as costs go up and income goes down. This squeezes the disposable income of parents significantly compared to the amount of spare cash they had before children.

The most significant across-the-board government support doesn’t kick in until a child turns 3, when you are entitled to funded hours from local nurseries either 15 or 30 hours depending on how much you work, and your income level. 

However, for those on a low income, Universal Credit (or tax credits) can cover up to 85% of childcare costs. (Note that applying for Tax-Free Childcare while on Universal Credit will mean that your Universal Credit help with childcare is stopped).

The table below summarises the main sources of help with childcare costs.

What benefits can I get to help with the cost of children?

There are some benefits available to most families with children, such as child benefit and others paid only to those on a relatively low income, such as Universal Credit or Child tax credit.

Child benefit

Child benefit is a social security benefit for parents. You get £20.70 a week for your eldest or only child and £13.70 a week for any additional children, up until their 16th birthday – or later if they stay in education or training. It’s a useful £1,788.80 a year for a family with two children who are eligible.

Whilst child benefit is payable regardless of income, higher income families receiving child benefit may find themselves with a tax charge as a result. In 2013, the Government introduced something called the High Income Child Benefit Charge, which requires those who earn more than £50,000 a year to pay a tax charge. If someone in the household earns more than £60,000, then the tax charge is equal to the amount of Child Benefit that the family receives. 

Even if you or your partner earns above £60,000 and you don’t want to claim Child Benefit, you should fill out the form, as doing so will entitle you to National Insurance credits towards your state pension. Without these credits, you may not receive your full state pension entitlement when you retire because of gaps in your NI record for years spent at home with children.

Child tax credit

To get the maximum amount of child tax credit, your annual income will need to be less than £16,105 in the 2019-20 tax year. 

If you earn more than this, the amount of child tax credit you get reduces. Various online calculators are available to help you work out how much you might get, including at www.which.co.uk and at www.entitledto.co.uk. You might also be able to claim working tax credit (see below).

The elements of child tax credit are:

• Child element. This is included for each child born before 6 April 2017. For those born afterwards, a child element is only included for two children or less, with a few exceptions for multiple births, or if your child is caring for a child.
• Child disability element. There is a rate for a disabled child, as well as a severely disabled child rate. Which one you get depends on the circumstances of the child in your care.
• Family element. Each family will be given one family element if there is a child or children born before 6 April 2017. This is not included if the child or children are all born after this date.

Working tax credit

The maximum amount is payable for those earning less than £6,420 a year. If you earn more than this amount, you lose 41p of the maximum amount for every extra £1 you earn. The minimum number of hours you have to work to qualify for working tax credit depends on your age, whether you are part of a couple, whether you are disabled and whether you have children.

To get a feel for the total amount you might get from child tax credit and working tax credit, the following table from the Which? website will give you some idea. Note however that tax credits are gradually being phased out and replaced by Universal Credit which has its own set of rules of entitlement.

As well as a sustained drop in income, some other knock-on effects to think through are:

• Reduced retirement savings for the mother
• Reduced borrowing ability for buying a new home/remortgaging
• More stringent budgeting for general living costs
• Greater risk of going into debt if big expenses are incurred
• Possible loss of career progression for the mother

Some lenders will take a more generous view than others, however, so using a broker can help, as they are likely to know which banks and building societies might, for instance, take into account how long you will be paying childcare costs for, or whether you receive free help from a grandparent.

Also be sure to declare any child benefit payments you receive, as these will count towards your income in the eyes of a lender.

If you are already a homeowner and want to remortgage or move, the same lending restrictions could apply, so it might be better to make any big changes before childcare costs arise.

Rule 1. Budget, budget, budget

To work out the kind of budget you will need to be on, check out pain point 1.

You need to work out what your income is likely to fall to once you have a baby, then work out what your new joint disposable household income will be, then add in a big new spending line: “BABY” to all of your other outgoings. As noted earlier, a working assumption of £8,000 per year or £666 per month is not a bad place to start, especially if you expect to have childcare costs. 

If we take an example couple – let’s call them “Ben and Natalie” on the typical joint disposable income for their age of £33,844 – or £2,820 a month.

Before children, their outgoings look like this: rent is £833 a month – the average for a privately rented home in England, and they spend £400 a month on food. Other bills including council tax, energy, fuel, water and phones come to about £400 a month, so their basic living costs come to more than 50 per cent of their joint net income. 

They are saving £300 a month towards a deposit, too. After these outgoings, they have about £900 left over for “discretionary” or non-essential spending on clothes, going out, holidays and other savings. 

Here’s what changes with the arrival of their first baby:

Let’s assume that Natalie, who earns £25,000 a year gross normally, wants to take a year of maternity leave when the baby is born. 

Her employer offers six weeks’ full pay, six weeks’ half pay and the rest is statutory pay - currently £148.68 per week. She will earn £9,827 for the year, or £818.93 a month (she wouldn’t pay tax on this income as it’s below the personal allowance threshold), compared to her normal net pay of £1,711.This means that
the couple have a disposable income £900 a month lower than normal – or about £1,900 rather than the £2,820 they are used to receiving, for this year. This is almost equal to the amount they usually have left over for discretionary spending – so they are only just in the black.

The problem, of course, is that their outgoings have actually gone up – by £333 a month (they aren’t paying for childcare yet). So they have to cut their other spending by about £300 a month in order to avoid going into debt.

The easiest costs to cut might be their energy, fuel, phone contracts and food bills – so making sure they are on the cheapest deals and shaving as much as they can off their food shopping could help with some of this.

It’s clear though, when looking at these figures, that the couple need to have some money saved up in advance to cover the shortfall in their monthly budget during Natalie’s year of maternity leave to avoid going into debt (we consider what a savings plan might look like below).

But in the next year, when Natalie goes back to work, budgeting gets even tougher as their outgoings go up again, because they begin to pay for childcare….

When Natalie does return to work, she goes back part time: three days a week. She is now earning £15,000 a year. Her monthly net salary is £1,144 a month.

So the household income is down by £567 a month – or 20 per cent - compared to what it was before they had the baby - but it is up on what they earned in the first year of their child’s life.

In order to work, Natalie is paying for part-time childcare, which costs her £128.98 a week – or £558 a month. A combination of new costs (childcare) which they didn’t have before and reduced income from Natalie working part-time has wiped out all of the discretionary cash that they had each month – and they have little spare cash to cover any emergencies, such as boiler or car breakdowns.

Summary: How to budget

1.  Know what you have left to spend after all essential outgoings
2.  Try dividing your monthly discretionary amount by the number of days in the month to give you a rough daily spending limit
3.  Keep a regular, monthly check to record any ups and downs in spending
4.  Shop around for the best prices on phone and broadband bills, TV packages, utility bills, insurance costs etc., and always challenge any renewal quote you are offered by ringing up to see if a better deal is available.

Rule 2. ANTICIPATE future work and life goals

Try to work out how likely it is that you will go back to work full-time and when, based on what you do know, such as your employer’s attitude to flexible working, how much you earn and how long you will be paid during parental leave. Whilst you can take the full first year off work, statutory maternity pay (to which you may have a legal right) ends in week 39 – so if you take the whole 12 months off you probably won’t be earning anything for the final three months, unless your employer’s scheme is unusually generous.

It’s also important to consider how you think you will feel about returning to work – emotions are not straightforward when it comes to taking your baby or toddler to nursery or a childminder for the first time and it’s good to keep your options open if you possibly can, rather than feeling forced to return to work. If you expect you won’t want to rush back, then budget and save more so that you can accommodate this plan.

Also think about any other big costs that are likely to crop up in the next few years, such as a first home purchase. Maybe even a wedding, if you aren’t married yet but think you might like to. 

Think about how all of the costs associated with having children might affect these plans, too. For example, if you are saving into your family fund, how much if at all are you prepared to eat into the home deposit savings? Are you happy to delay a wedding for a few years or perhaps do it on a budget? It will be hard to save for a large number of expensive life goals simultaneously so some prioritisation is a good idea.

Rule 3. PREPARE and do your research

1. Pay whilst you are off work for the first year

Check through your employer’s parental leave policy and pay arrangements. As explained earlier, these vary dramatically from little more than statutory pay to generous year-long pay packages where your employer continues to pay you your whole salary for almost the whole duration (although this is rare). 

You should also check your partner’s parental leave package, as this will affect your choices in that first year. You should be able to take shared parental leave, as this is a benefit to all new fathers now, for the first 50 weeks. However statutory shared parental pay, like statutory maternity pay, is minimal at £148.68 a week in 2019/20 and is paid for 37 weeks rather than the 39 weeks of statutory maternity pay entitlement. 

Paternity pay packages usually offer two weeks of fully paid leave to new fathers, followed by the statutory rate for any shared parental leave taken by the father after that up to 37 weeks – this is less generous than the enhanced maternity pay that is usually offered
to mothers.

For that reason, most couples still find it most economical for the mother to take more time off to look after the baby rather than the father. BUT (and it’s a big but) some large employers are improving their paternity pay to bring it into line with pay for mothers.

If more employers do this, it will become feasible for more fathers to take time out to look after the baby in that first year and couples will have more choice.

Top tip: One thing to consider is saving up any holiday entitlement you have during the year you are pregnant and adding it to your parental leave, to give you more paid time off, although you obviously need to look after yourself before the child is born and take proper time off.

2. Other things to prepare for – where you will live and who will look after the children

It’s a good idea to prepare for even further ahead than the first year, if you can. For instance, are you in the catchment area for local primary schools? This is more of an issue in some areas than others. It might sound crazy to think about something like that before you’ve even had children, but if you did decide you wanted to move, you might prefer to do it before children arrive on the scene. And you might want to avoid having to move twice in order to get into your desired catchment area and having to pay extra stamp duty.

It’s also a good idea to sound out relatives who might want to help with childcare well in advance, and to make sure any arrangement involving them is clear to everyone involved. The last thing you want is to plan to return to work on the basis of free childcare from grandparents, only to find they meant one day a week, not full time.

Rule 4. SAVE while you can

Your costs and income level are likely to vary a lot over the first few years of your children’s life and if you’ve both been comfortably managing on your joint income in the years before children, suddenly struggling
to manage can come as a shock. Childcare costs in particular, at around £1,000 a month on average for a full-time place for a child aged 1 or 2 (although it does tend to fall after that) can be tough to meet.

Saving as much as you can before the concertina effect of higher costs/lower income kicks in will give you breathing space later on.

If you like the “jar” method of saving, where you save for different purposes in different jars or pots, like Christmas, holiday, house etc, then starting a “family” savings fund, which is specifically for this purpose, is a good idea. 

How to start a family fund for child one

If we take the average annual cost of a child through its life to be £8,000 a year, this works out at £666 a month.

It will be far easier to save this money out of your joint disposable income before you have your first child than it will be to try to pay your new child-related costs out of a diminished disposable income once they are born.

Where to put your savings? 

Consider a regular saver attached to your bank account, if your bank offers one, as these can offer more generous interest rates. You want to be able to access your money when you need it. Generally, interest rates on instant access accounts tend to be lower than those that tie your money up for longer.

...saving on the spending

It’s hard to avoid spending on baby things. But when it comes to buying the things you need, if they are rush purchases, you are more likely to spend too much. Scour NCT sales, local Facebook groups and willing friends’ attics for much cheaper items. 

Most parents would agree that buying new toys and clothes for their babies and toddlers was a huge waste of money, as second hand items are often hardly used and in good condition, for a fraction of the price.

It’s a lot to take in, but…

Having children is an expensive business and it is worth putting some thought (and savings) behind your family financial plans, to give you time and space to focus on the important things - like enjoying time with your children.

About 1.4 million people become parents every year – and most will somehow manage through the toughest times. In the end, how you get through will depend on luck, such as the parental leave offered by your employer, as well as judgment and planning. Your work, childcare and support patterns can change a lot over the early years and before you know it, financial pressures are not the worry they might have been at the beginning.

If you can get through the pre-school years without too much pain, you’ll have done the hard bit and that concertina should start to expand again. 

Good luck!