After months of planning, you are now a proud parent. Starting today the rest of your life will change. No longer will you worry about getting reservations at the “in” restaurant. … or any restaurant. Nope. You won’t have time. Nor will you have energy. Both will get zapped, and that is okay.
Instead, you will be figuring out breastfeeding, bottle feeding, sleep schedules, diaper changes, educational and interesting toys for a baby that just stares. And all of this is okay. In fact, it is better than okay, it is great! You are now on the next stage of your journey.
As this journey begins, you may feel overwhelmed. Not just physically and emotionally, but also financially. Questions such as “Do I need to set up a 529 college plan now?” or “What about life insurance?” pop in and out of your head. No one wants to think about this stuff when you bring a child home, but you have to. While the 529 may not be urgent, having life and disability insurance is if you are not financially independent.
So today we will discuss a few things to get your financial house in order and discuss parent finances, because at the end of the day the nursery is important, but so is the bank statement. So here are a few financial steps to consider as you become a parent.
If this is the first time you are thinking about your finances, don’t fret. I suspect you are not alone. My plan below follows steps that are different than if you did not have kids, but despite the order, all steps are applicable to either kid full or kidless people.
This is probably the most important thing you can do on day 1 of having your child if you are the breadwinner. In reality, you should have done it when you found out you were having a kid. Why?
A term-life insurance policy will protect your family from financial disaster if you die (and are the breadwinner). Term-life insurance will pay out a fixed amount from as low as $50,000 (probably even lower) to millions of dollars if you die. My term-life policies near $3 million in fact. That is the “life insurance” part of it.
“Term” means that it is a contract/insurance policy for a set amount of time. Typically people purchase term-life insurance until they are 65 years old. By then most children are grown and no longer depending on their parents for financial support. Additionally, most people are retired by then or at least drawing Social Security.
Term-life insurance should not be confused with “whole” life insurance. Chances are you do not need a whole life insurance policy and definitely not until you have figured out some other financial matters. If someone is trying to sell you a whole life policy, thank them and walk away. You do not need it at this point in your financial planning. Sam talks about whole life in the comments of “How much life insurance do I really need” and the White Coat Investor has written about it various times. We are not going to go through whole life insurance for this article, but I thought you should at least be warned.
How does term-life insurance work?
Well for a low monthly or annual fee (and they are typically quite reasonable), you are insured for a set amount (say $500,000). If you die, then your beneficiary (typically your spouse, your child, or a trust.) gets a lump sum of tax-free money. That money is their’s, and they can do with it as they please.
How much do you need?
Everyone’s situation is different. I personally have student loans in the six figures and a mortgage that is higher than that. My spouse is not currently employed as she is raising our son. If I die, she will be hit with a big loss of income and have at least the mortgage to pay down (thankfully my federal student loans will be forgiven). So I chose to get a policy in the millions. For your family, a few hundred thousand may be enough.
I would recommend calculating your debts and your post-tax monthly income. You should have at least enough to pay down your debts and likely at least 3 to 5 years worth of income. If your spouse has a job and earns a decent paycheck, then the income becomes less of an issue. Still, your death would likely lead to time off of work. All of this should be considered in your amount purchased.
So considering that term-life insurance is not too expensive, you should buy a policy until you are 65 years old or when you expect to be retired with the kids out of the house. You do not need a whole life insurance.
Arguably as important as term-life insurance. I do not know if the chances of dying or having a permanent disability are higher, but you should be covered for both. Disability is a very real concern and can have a lifelong impact on your family.
It can happen to you!
You don’t think it can happen to you? Well, don’t be so confident. I have a very fit friend who was visiting Mexico with his wife and 6-month-old son. He was walking on the shoreline, barely in the water. His wife ran upstairs to change their child’s diaper. In that short time, a big wave came and knocked him into the ocean. Bam. He was immediately paralyzed from the neck down; he could not move. Screaming for help every time he could and holding his breath as the waves came over him. Eventually, some bystanders heard him and pulled him into shore. To make a long story short, he was taken for surgery and now is no longer paralyzed. He is, however, out on disability and has been for a little over a year.
Did he think he would ever be taken out by a wave while standing 1 foot in the water? No way. Is he lucky he has disability? Really lucky. The point is that you have to insure for catastrophe.
How much disability insurance do you need?
This is also a personal decision. The insurance pays out tax-free. So for me in a high tax state like California, a policy that pays 60 percent of my income for disability would leave me with a take-home pay higher than my current salary (thanks to taxes). Most policies cover 50 to 65 percent though I am sure you can buy more if you want.
You should get a disability insurance that is “own-occupation.” This indicates that if you are disabled (say as a pilot) that they will pay you because you can no longer be a pilot. Sure you can go get a desk job, but the disability insurance will still pay out. This becomes important for doctors particularly.
If you are a surgeon and you can no longer do surgery, you want to be considered disabled even if you can still work in a different high-paid position. There are policies out there that do not state “own-occupation.” If you are disabled from your primary job, the insurer may force you to take another type of job and not pay out the disability. This is a bad idea, consider the potential difference in take-home pay between your current job and another job you might be able to do, you should not buy these policies.
Disability insurance is more expensive than life insurance, but a necessary piece of the puzzle. Shop around, find an “own-occupation” policy, and determine if you need 50 to 65 percent of your income if you are disabled.
Wills and trusts
A bit more complicated, but something to consider, is setting up a will or living trust. There are many reasons to do this and Financial Samurai recently discussed some of the benefits to do so, so I won’t go over the semantics in detail.
Why set up a will or trust?
For us, the main purpose was to lay down a plan for what will happen to our son if my wife and I die. Who should raise him? What do we want done with the money from our life insurance plans, retirement accounts, etc.? Should our son get them at age 18 or older. It lays down a guideline for his guardian.
Another reason to set up a trust is to avoid probate (this is not true with a will). As discussed in the benefits of a revocable living trust, probate can get expensive. Plus it ties up the funds until they have gone through the legal system. In some cases, this can take months.
I personally set up a trust using LegalZoom which turned out cheaper than using a lawyer. Do what is comfortable for you but consider this important step, particularly if you have numerous assets.
Another common concern amongst new parents is preparing a college fund. While I think paying for your children’s college is amazing, it is not necessary. I would recommend first paying down your own high-interest debts and funding your retirement accounts such as a 401k (enough to at least receive an employer match) and Roth IRAs, before considering funding a 529 plan for your kids. Your future financial health should be managed before their potential college fund for 18 years from now. If you can afford to pay for your kid’s school, then great. Now you can consider a 529 plan.
What does a 529 plan do?
It allows you to put after-tax dollars into an investment account for your children. If those funds are then used to pay for education, they can be used tax-free. Meaning you do not pay any capital gains taxes on the interest earned. If you do not use the funds for education or pull them out early, you will be taxed on capital gains plus a 10 percent penalty.
What state should you set up a 529 in? First I would look at your home state. When I lived in New Orleans, I went with Louisiana Office of Financial Assistant’s plan because there was a match from the state. For my income bracket it ended up being about $100 per year per account (mine and my spouse’s), but that ended up being an extra $200 a year. The match is better for individuals with lower incomes.
I have since moved to California, and there is no tax advantage to having an account within my state at my income. So what did I do? I opened up a plan through the Utah Educational Savings Plan. Why Utah? They offered low-cost Vanguard plans and have a fairly good reputation. These offerings were better than the offerings in Louisiana when I was no longer a permanent resident. You can choose any of the 50 states, and some research may be worth your time.
Sums it up
So that about sums it up. Congratulations, you are a parent. To recap you should:
- Buy a term life insurance policy to cover at least your debts and a year or two of income.
- Buy disability insurance to cover at least 50 percent of your post-tax income.
- Set up a will or trust to provide a guide for your childrens’ guardians in case you and your spouse die and to provide protection of your assets.
- Set up a 529 plan once you have handled your own high-interest debts and arguably retirement investments such as a 401k (to get at least a company match) and Roth IRA.
What are your thoughts on these steps? How many of you set them up?
“Dads Dollars Debts” is a cardiologist who blogs at his self-titled site, Dads Dollars Debts.
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