“You’ll never actually feel ready to start a family,” my friend and mentor told me over a pint of Guinness. My wife was ready, but I didn’t feel prepared--emotionally or financially.
As a young financial planner, I wanted to take a methodical approach to preparing for a family before starting one. My wife was ready to start painting the newly donned baby’s room and buying a crib. My version of nesting was to beef up our fledgling emergency reserves, upgrade our life insurance, get a will done and open an education savings plan--just for starters.
And then, life happened. (Literally.)
Whether you just celebrated Junior’s third birthday or you’re in the envisioning stages of starting a family, there are likely more (and more important) financial planning to-dos associated with this life event than any other. That’s in part because this is so much more than a single event--it’s a transition into parenthood that begins, for some, years before their first child is born and lasts, hopefully, for the rest of our lives.
Here is a prioritized list of financial planning moves that should help you navigate this benchmark life transition, whether you’re preparing for or reacting to the growth of your family:
Live off of less than 100% of household income - Most families experience a decrease in income as a result of one or both parents scaling back at work. If you’re already living off of 100% of your income, that’s going to be a problem.
Even if you’re not planning on having kids just yet, I recommend that you and your new spouse or partner live off of far less than 100% of your income. (Aim for 50% to 75%.) This will give you more freedom to embrace the change in life that is sure to come.
Increase cash emergency savings - Yes, most families see a decrease in income, but all families can anticipate increased expenses when a new household member arrives. As first-time parents, we fret over anything real or imagined that could harm our little ones. That’s not likely to change (until number two!), but if you have sufficient emergency reserves, at least you won’t have to stack financial stress on top of emotional stress.
Having three months’ worth of household expenses in cash is a solid buffer for most households; but before you get to three, you have to start with one. That’s a huge win because you’re no longer living paycheck-to-paycheck.
Purchase life insurance for the new parents-to-be - Life insurance is a nice-to-have for D.I.N.K. households (Dual Income No Kids), but it is a must-have once kiddos are in the picture. For income-earning moms and dads, consider getting term life insurance with a death benefit that is 15-times your salary. This should help ensure that any loss of life is not compounded by a loss of income for the foreseeable future.
Even a stay-at-home spouse (without income) needs life insurance too. $250,000 to $500,000 should offset the inevitable increase in childcare for years to come.
But what type of life insurance, you ask? In almost every case, the answer is the simplest and cheapest option--term life insurance. Consider a term for between 20 and 30 years, depending on how many more munchkins may be coming down the road.
Have basic estate planning documents drafted - Estate planning documents aren’t just for the wealthy. Most adults--and all parents--should have three important documents created: a Will, Durable Power of Attorney and Advance Directives.
In addition to offering guidance on how your assets--including your new life insurance proceeds--should be handled in the case of your unexpected demise, the most important thing your Will does is designate who the Guardian (effectively, the new parent) would be for your minor children. If you don’t decide, the state you live in will do it for you!
But in addition to a Will, each spouse should also have a Durable Power of Attorney (which gives someone the ability to act on your behalf in financial matters if you’re unable or unavailable to do so) and Advanced Directives (which authorizes someone to make medical decisions for you in the case that you’re incapacitated) drafted by a qualified estate planning attorney.
Update Your Beneficiaries - After getting your will done, you’re finished with all this estate planning business, right? No, actually, any retirement accounts (like 401ks, IRAs and annuities) as well as life insurance policies give you an opportunity to direct your assets through beneficiary designation forms--and these forms actually supersede elections in your will if they’re in conflict.
This makes it especially important to sync all of your estate planning documents, including your beneficiary forms. In most cases, you’ll want to designate a primary beneficiary (like your spouse) and a secondary beneficiary (like your kids).
Set up 529 college savings plan - The Wall Street Journal estimates the cost of raising a child at around $250,000, but with the cost of education having outpaced inflation by a meaningful margin over the past 20 years, it’s not hard to imagine blowing all of that budget just on school! That is reason enough to start saving early for your children’s education, and the best place to save is likely in a 529 college savings plan.
How much would you need to save in order to send your kids to college? I estimate $350, $700 and $1,200 per month for in-state, out-of-state and elite private school, respectively--from the time the child is born.
Most parents can’t--and indeed, shouldn’t--save that much because it would mean prioritizing their children’s education over their own long-term financial health (read: retirement savings). But it still makes sense to open and fund a no-load 529 with as much as you can--and by all means, don’t forget to let well-meaning grandparents, aunts and uncles know about the existence of these accounts as well. Education, after all, is the gift that keeps on giving!