Traditional wisdom says a parent stays at home to raise their children because they can afford not to work. While this is still true for many families, the other side of the equation is also becoming true – some parents now choose to stay home because they can’t afford to work.
With the cost of daycare spiraling out of control, a lot of parents are finding out that after factoring in the cost of daycare, commuting and other work related expenses, holding a job doesn’t pay enough. In some cases they even have to pay to work!
The rising cost of daycare
The cost of raising a child has been steadily climbing up. According to the latest report from the U.S. Department of Agriculture, it now costs nearly $250,000 to raise a child to the age of 18 without including college costs. The top expense, 30 percent, is housing; which I believe can be controlled and reduced by parents. The second highest expense is childcare, which is what comes as a surprise for a lot of new parents.
The National Association of Child Care Resource Referral Agencies conducts a survey on child care costs around the country every year. Each passing year the cost of childcare has been consuming more and more of an average family’s budget.
- Daycare now costs more than 4 years of in-state college tuition in 31 states and the District of Columbia.
- In 28 states, the yearly cost of child care for two children is more than the annual minimum wage; which means a single mother of two, working a minimum wage job, is forced out of her job, to live on welfare.
- The cost of child care fees for two children exceeded housing costs for homeowners with a mortgage in 19 states and the District of Columbia. Center-based child care fees for an infant exceeded the annual median rent payments in 21 states and the District of Columbia.
- The cost of full-time, center-based care for two children is the highest single household expense in the Northeast, Midwest and South. In the West, the cost of child care for two children is surpassed only by the cost of housing in the average family budget.
For families living at the federal poverty level, daycare is unaffordable. For example, families of three in Massachusetts living at the poverty level have to pay more than 86 percent of their income to care for an infant full-time. Even families of three earning an income of 200 percent of the federal poverty level struggle to be able afford daycare; they have to spend 43 percent of their income to care for an infant.
So do you have to be rich to be able to afford to work?
How to calculate if daycare makes financial sense?
From a purely financial point of view, many new parents are shocked to find they are working for pennies after paying for childcare. Given the added stress of work, workplace politics and the time spent commuting; it is good exercise for any couple who are thinking about starting a family to calculate how much they are bringing in after factoring in childcare expenses. This needs to happen before starting the discussion on whether it would make sense for one of them to stay home and raise the child.
If both parents are working before they had a baby, does it make sense for them to continue to be a two income family while the child goes to daycare or should one parents quit their job to stay home? You can calculate how much of the second income you are taking home after factoring the daycare cost and work related expenses (which you won’t have if you quit and stay home) using the following six steps –
Step 1, Collect the following information: Your partner’s income, your income, daycare costs, number of dependents, filing status (single, married filing jointly, head of household), standard deduction for this year or an estimate for itemized deduction (you can take this amount from last year’s tax return, if your life situation didn’t change).
Step 2, Use a calculator to find your marginal tax rate: First ignore your income; just use your partner’s income and the rest of the information in a calculator like this to find out your marginal tax rate (marginal tax rate is the rate you would pay on an extra dollar of taxable income).
Step 3, Find out how much of your income you will pay in taxes: Now add your income and use the same calculator to see how much extra tax you will pay.
Step 4, calculate your State taxes. Find the tax rate tables for the state you reside in and calculate how much you will be paying in taxes. Depending on the state you might be able to find a calculator on your State’s revenue board website.
Step 5, Subtract taxes, transportation, daycare and other work expenses. Add up the federal and state taxes, cost of commuting to work, daycare expenses and any other work related expenses (dry cleaning, membership dues, uniform, etc.) as you don’t have to spend on any of those if you don’t work.
Step 6, Calculate your take home income after childcare expenses and taxes. The amount you get from step 5 will be the take home income you will have after paying someone to take care of your kids. You can translate this take home income to an hourly wage by taking the amount from step 5 and divide that by total number of hours worked in a year (52 weeks x 40 hours).
Now is that worth it?
Case study #1: Mike earns $100,000 as a software engineer and Sally earns $40,000 as a teacher; they have two kids aged 6 months and 4 years. So translating that into tax speech, they have two dependents and they will be filing their return as married filing jointly. They are contemplating putting their kids in daycare for Sally to return to work.
- Federal taxes: They have a modest house so they don’t have much to itemize, instead they take the standard deduction; which for 2014 is $12,400 for their filing status. Using the calculator with Mike’s salary of $100,000 (Note: if they contribute to their retirement the taxable wage and therefore their tax rate will change) they will pay $9,863 in federal taxes. Now adding Sally’s salary and redoing the taxes with $140,000, their tax liability climbs to $19,663, an additional $9,800. So roughly 25 percent of Sally’s salary goes to Uncle Sam.
- State taxes: If they lived in Oregon, Sally’s income will be taxed between 9 and 9.9 percent depending on their federal taxable income, which will be $3,600 – $3,960.
- Expenses: In Oregon, cost of daycare for an infant is $13,452. For a 4 year old it is $10,200. So that is a total of $23,652. Add to that $150 in gas and insurance for a month or $1,800 per year in transportation, ignoring wear and tear and maintenance on the car.
Sally’s annual take home income after childcare expenses and taxes: Income – (Federal tax + State tax + expenses); $40,000-(9,800+3,600, the lower estimate, + 23,652 + 1,800) = $1,148, assuming she doesn’t have to buy any supplies for her classroom at her own expense. Sally brings in $1,148 a year after factoring in the taxes and childcare expenses. That makes her hourly wage a little more than half a dollar ($0.55). If Sally can keep her teaching credentials current and is in a school district where it is relatively easy to go back to teach, she might consider taking a break for a few years.
Case study #2: Laura and Dustin are both postdoctoral fellows doing research for a very prestigious university in Massachusetts earning the standard NIH salary of $42,000 each per year. They have a 3 month old.
- Federal tax: They rent and take the standard deduction. According to the calculator, with just one salary they would pay $1,348 in federal taxes. Adding another $42,000 brings it up to $7,648. So the additional $42,000 would be taxed at 15 percent, with $6,300 in extra taxes.
- State tax: Massachusetts state tax rate is 5.2 percent for 2014, which will be $2,184 for $42,000.
- Expenses: In Massachusetts, they pay $25,200 to care for their infant during the standard 9 AM to 5 PM time slot. They work long hours, so spend an additional $200 a month or $2,400 per year for after-hours care. They use public transit with the university discount, so the cost of commuting is $80 a month or $960 for each.
Laura’s (or Dustin’s) hourly wage: Subtracting their expenses ($6,300+$2,184+$25,200+$2,400+$960) from the second income of $42,000, leaves $4,956. So the take home income from the second person’s job after taking childcare expenses and taxes into account is $4,959 per year. They work an average of 50 hours per week making the hourly rate $1.9. If we look at it from a purely financial perspective, it is obvious that either Laura or Dustin should stay home to take care of the baby as they don’t earn enough to justify working. But it is not that simple, both of them have high earning potential and taking a break from their career would have a lot of negative consequences when they start applying for post-academics jobs. Additionally, they love doing research so they would be unhappy if they stayed home with the baby.
As you can see, it is not always black and white; there are a lot of long term consequences to taking a break from a career for a few years.
What is the long term cost of staying at home?
According to a new analysis by the Pew Research Center about one-in-ten mothers with a Master’s degree or more and an annual family income of $75,000 or more are “opting-out” of the workforce to stay home and care for their family.
69 percent of mothers opting out cite caring for their kids as the reason. Is the short term expense of daycare reason enough for parents to quit their job? There are plenty of reasons why it is not a great idea to take a break from the workforce –
- Motherhood penalty: Only 9 percent of the women in the work force earn $75,000 or more annually, 37 percent earn between $30,000 and $74,999 and 54 percent earn less than $30,000. It makes most sense for the lower earning member of the family to step away from the workforce. In most cases, it is mothers who stay home to look after children and it is cited as one of the major reasons for the wage gap. Currently women earn $0.77 for every $1 earned by men. Over a 40-year career, the average woman will lose $431,000 to the gender wage gap.
- Direct income loss: By taking a break of 5 years, what is the amount lost by not saving for retirement in 401k for those years? How much is the income loss in those 5 years? What is the cost of compounding all this income loss for 30 years until retirement at 7 percent return? According to a study, women who stay out of the labor force for three or more years, lose 37 percent of their earning power.
- Promotions and income loss from that: Taking a 5 year break will most certainly be a career stalling act. Where would you be in the corporate ladder if you had worked through those 5 years? How much would your salary have increased due to promotions, bonuses and pay raises?
- Other intangible losses: By staying at home you not only lose money, but skills stagnate, seniority is lost and connections fall away. What about any other opportunity costs?
- Personality clash: Staying at home to care for kids is not for everyone. Some parents are much better parents because they work outside home. They are much happier with having workplace interactions, professional challenges and generally love their career.
Stepping away from the workforce to care for your kids will save money in the short term, but is that best for your family in the long run?
Options to possibly help cost and career
Childcare is expensive, but quitting your job is equally or even more expensive, especially if you are a career-minded person. You can explore several other avenues to reduce the cost of childcare:
- If you have family who can provide free or low cost childcare, that might work for a part-time solution.
- Can you team up with other parents and share a nanny?
- Do you have a YMCA (or something similar) that provides childcare on a sliding cost basis? If you are in the low income bracket, you might pay next to nothing for someone to care for your child.
- Au pair is not free but can be much cheaper than traditional daycare.
- Try a co-op daycare. These are typically church or community groups where you have to volunteer for one day a week to get childcare for one week (other parents do the same).
- Can you manage your shifts with your partner so that one partner works during the day, the other at night?
- Can you work from home and hire a mother’s helper?
- If you work part-time, can you trade care with another mom working part-time?
A lot of families choose to have one parent stay at home to raise the kids until they go to school not for financial reasons but because they believe that is what is best for their families. This post is not about whether one should stay at home or work; rather this post is to help people who are on the fence about going back to work purely for financial reasons. In that case, look at the big picture, not just the first few years but a few decades down the line and plan ahead.
Photo credit: Children of Chaldran, West Azerbeijan. Flickr Creative Commons.