Financial Planning for NEW PARENTS
Why do financial planning?
There’s a sad saying amongst financial planners that states; “a great majority of people spend far more time planning for a single summer vacation than they spend throughout their entire lives on financial decisions.” Financial Planning is the process of determining your goals, and then structuring your money inflows and outflows to best meet your goals. The purpose of developing a financial plan should essentially be to help you get what you want as quickly as possible within smart and reasonable parameters. Having a written plan increases the likelihood of people meeting their goals by over 2 times, as well as reducing stress!
The 4 Big- areas of concern:
1. Budgeting
2. Saving and Investing
3. Insurance Coverage
4. Estate Planning
1. Budgeting:
The most important aspect of budgeting is that you need to create financial harmony, and your budget is the foundation for your (happy) financial lives. You must budget realistically for fun and relaxation as well as for a rainy day. So how do we do this? Communication AND Honesty. It’s the ONLY way to know how your spouse views money. If you’re single, actually communicating to yourself the following mantras is a key element in successfully budgeting!
First, take the time to provide open accounting to your spouse. Most financial arguments are not about how to spend your money but about how money was actually spent. Financial accountability, openness, and honesty are essential in marriage.
Next, make saving money savings your first priority. Pay yourself and your kids first. Couples should agree on a savings rate and should prioritize their savings above all other budget categories. Savings should be automated and protected from impulse spending habits. A basic rule of thumb is to save at least 10% of your gross earnings each year.
Set a limit on what you can spend first, without getting the approval of your spouse. This allows each person autonomy in their financial lives. However, each spouse must sign off on spending that might be a budget buster. If your spouse asks you to wait before making the purchase, lean toward waiting graciously. Ask what you would do if you did not have the money at all. Delaying a large purchase even by a month can significantly increase your financial health.
Set rules for the acceptable use of credit. In my experience, the easy use of credit cards ruins much financial harmony. It is better when the use of credit cards is limited to only certain required budget items. Using a credit card for groceries or gasoline may be harmless. But when credit cards are used for clothes or eating out, optional spending is unnecessarily inflated to the credit card’s high rate. Credit allows couples to avoid asking the tough question about what they would do if they did not have the money.
Agree together that ignorance will not be used as an excuse. Both parties must be willing to learn. Just like a good love life, finances cannot be handled well by just one party. Many problems stem as much from ignorance and abdication by one party than spending by the other. If you don't have the time or the interest to be involved in the family's finances, then you may be the problem. Ask for help and start learning.
2. Savings and Investing (5 parts):
Decide where to save, then how much…but most importantly…just do it!
I. Saving for your children: Biggest expense will be college - Use 529 Plans!
Families are finding it increasingly difficult to save for college. A public in-state school for 4 years costs about $55,000/ ~$85,000 for UC Berkeley/ ~$185,000 for Stanford or
That said, you’ll want to save as much as practical into a 529 Plan.
The 529 plan basics
There are two types of 529 plans: pre-paid tuition plans and college savings plans. Every
· You can fund 529s with $250,000 (sometimes over $300,000) of contributions
(growth in the accounts may exceed the contribution limits, which is acceptable).
· Contributions are considered completed gifts, however, the owner (parents or grandparents) retain complete control over funds.
· Each owner can contribute a maximum of $60,000 in a year without incurring gift tax. For example; husband and wife (or grandma and grandpa) can make a combined gift to little Bobby of $120,000 ($60k each) to the 529 Plan for Bobby as beneficiary of the plan.
· Realized earnings within the plan are tax free.
· Distributions are tax free for qualified higher education costs (tuition, books, supplies, room & board) no transportation costs or personal expenses allowed.
· The owner (generally the parent or grandparent) has complete discretion and control of all funds within the plan. Beneficiaries can be changed once per year, but watch out for generation skipping tax.
· 529 Plans are excellent estate planning tax tools for grandparents, especially if grandparents have a taxable estate (estate value of over $2,000,000). Why? Because Grandparents can reduce an estate to value below $2,000,000 thereby avoiding estate taxability generally over 45%. Be careful of generation-skipping transfer tax (45%) if grandparent dies within 5 years of gift date.
There are hundreds of different 529 Plans, which one do I choose? Since CA has no tax deduction for contributions to 529’s, it opens up possibilities for other out of state plans. Our recommendations are for:
· College
· California
**Remember to reallocate investments as your child gets closer to college start date. Start out with aggressive investments, end up with conservative investments.
For more advice and recommendation about educational funding, see a College Planning specialist or financial planner who has training in this area.
II. Saving for Elementary or Secondary School expenses: Using Coverdell Accounts
· Savings of up to $2,000 per beneficiary (child) maximum – from all sources.
· Earnings grow tax free and distributions (withdrawals) are also tax free for qualified expenses.
· Qualified expenses include: tuition & fees, books, supplies & equipment, academic tutoring, special needs services (for special needs students), room & board, uniforms, transportation, supplementary items and services (including extended day programs but usually not after school day care).
· The purchase of computer technology, equipment, or Internet access and related services is a qualified elementary and secondary education expense if it is to be used by the beneficiary and the beneficiary’s family while the beneficiary is in elementary or secondary school.
· Coverdells can be used for post-secondary or higher education costs, but be careful of the coordination laws for distributions from Coverdells and other Qualified Tuition Plans. You can’t withdraw money from both accounts for the same expenses.
If you started saving in a Coverdell account at birth, $2,000 per year after 5 years at 6% earnings per year, your account would total $11,050. This could be used to pay for many expenses while in elementary or secondary school.
III. Saving for you & your children through your employer. Using the FSA, HSA, ESPP/ESOP.
Flexible Spending Accounts allow employees to direct before-tax wages into an account to be used for medical and/or dependent care expenses. It’s an absolutely great way to reduce taxes on items you’d have to pay for anyways. For example, we use a FSA to save about $4,000 per year for my daughter’s after school program. We’re in the 25% tax bracket, thus, this saves us 25% of $4,000, or $1,000 per year in taxes! Benefits of a FSA:
· Immediate taxable income deduction.
· Force savings into an account for future use (great budgeting device).
· Get a tax free payment for Health Care expenses (non-prescription costs, co-pays, etc.) or Dependent Care expenses (baby sitting, day care etc.)
· Keep in mind that if you don’t incur expenses for these funds by the end of the year, you will lose your investment!
Health Savings Accounts –
Benefits of using a HSA:
· The contributions remain in your account from year to year indefinitely until used.
· The interest or other earnings on the assets in the account are tax free.
· Distributions (withdrawals) may be tax free for qualified medical expenses – can be used for your children.
· An HSA is “portable” so the account stays with you if you change employers or leave the work force.
ESPP or ESOP plans:
First ask your Human Resources Department and use them if available. A typical ESPP plan will give employees the ability to discount the purchase price of their company’s stock – usually 15%. The employee can then sell the stock and usually lock in an immediate ~ 15% gain. Then put proceeds in a Coverdell or 529 plan for tax free growth.
IV. Saving for yourselves: Just as important because your kids will NOT fund your retirement.
First, determine what your investment goals are and then save regularly for those goals. Always save some for retirement, and not just the shorter-term goals or your children’s education or expenses. Try to save 10% of your gross earnings for retirement.
· Open and save into a Traditional IRA or, better yet, a Roth IRA if eligible.
· Save in your employer’s retirement plan (at least up to employer’s match if available).
· Save in a regular, taxable brokerage account. Yes, you’ll have to pay taxes, but you can access the money without penalties or incurring a taxable distribution.
· Build up 6 months worth of earnings in a savings account for an emergency fund. The emergency fund should be held in a savings account where you can readily access funds (so don’t invest this money in a CD). Keep the funds in cash and earn interest.
V. Investing:
Now that you have some money, how should you invest it? Follow these simple steps and you’ll be rich by the time you retire.
· Keep it simple. We regularly advise clients with less than $100,000 to invest in index funds. These funds are very inexpensive and provide the best returns for the risk they assume.
· Diversify! Buy index mutual funds or Exchange Traded funds (ETFs) across these sectors: US Stocks, US Bonds, Foreign Stocks, Foreign Bonds, Commodities & Natural Resources, Real Estate, and Cash. Divide your entire portfolio into these 7 sectors, placing 20% each in US Stocks, US Bonds, Foreign Stocks, Foreign Bonds. Then, with the remaining 20% of your portfolio, invest 5% in Commodities & Natural Resources, 5% into Real Estate funds, and 10% in Cash.
· Try to rebalance your portfolio yearly so that you remain in the above allocations.
· If you have trouble understanding this, please call your brokerage account representative or Aspire Capital Management, and ask for some help, but remember to keep it simple!
· DO NOT invest in something that you don’t understand how to get OUT of or can sell within a few minutes. DO NOT invest in something where you do not know exactly how much you’re paying in fees & expenses. We regularly see clients who thought they were “sophisticated” investors until they lost a lot of money or were not able to sell a product when they needed the money!
3. Insurance – Life and Property & Casualty (we’re leaving out medical, disability, and long term care insurance, for the sake of time, but call us if you want to understand these topics more thoroughly.)
Life insurance: Do I need it? If so, how much do I need?
If you have children, a mortgage, want to provide for educational expenses or you don’t want your family members to suffer financially if you unexpectedly die, then I always advise absolutely buy life insurance. If you’re single or don’t have anyone that would suffer financially if you died, then I generally recommend you save your money. Buying insurance is simple, however, you’ll want to know a few basics before buying a policy or policies.
How much do I need?
· If one or both spouses earn income: You’re going to purchase 2 separate policies (for each partner). Here’s a simple way to determine how much you’ll need:
1. Add one spouse’s income and any other services that you’d need to hire out if that spouse was not around (such as babysitting, tutoring, etc.) for an entire year. Also include annual college savings per year for each child.
2. Deduct any pre-existing insurance amounts like Social Security or employer pensions paid to surviving spouses.
3. Then divide that sum by 0.05. The 0.05 represents what you could relatively safely earn in interest & dividends from a income generating account. The idea is to be able to live off of the interest of the life insurance proceeds as much as possible and for as long as possible, while leaving the principal amount for emergencies or necessary expenses that exceed the interest payments. As well, this allows for a bit of protection from inflationary pressures that erode your purchasing power. If you have a large mortgage that you would want paid off, buy a mortgage payoff rider (discuss with your insurance agent).
4. Deduct any pre-existing policy amounts from employers or old policies that are still in full force and effect.
5. This is the amount you’ll look for to insure one spouse’s life. Sometimes, we encourage couples to buy 25% to 50% more than this amount if they’re estimating much higher earnings in the future.
Example:
Annual Wages of one spouse: $45,000
Other Annual costs (child care & tutoring): +$5,000
Total Gross need: $50,000
Less: Social Security Income: $24,000
Net income needs $26,000
Employer Based Life Insurance $90,000
1st: Divide $26,000 by 0.05. That gives us $520,000.
2nd: Deduct the $90,000 for the employer’s life insurance policy (if you have it) which comes out to $430,000 this is the estimate for how much insurance you would need to make things somewhat comfortable for now. This may seem like a lot of insurance payout, but it’s actually not…which is why in this case we would recommend purchasing a $500,000 to $600,000 policy. We frequently use this approach in our firm as this takes into account the erosion of your purchasing power due to inflation. For example: you buy a $150,000 policy today. Fifteen (15) years later, you die and the family gets $150,000. In 15 years, at 3.5% annual inflation rate, the actual value of that $150,000 will only be able to purchase roughly $89,500 worth of goods/services…not that much. What this means is that you should purchase more than you may think you’d need today for a few reasons. One, the insurance will be significantly cheaper when you’re young, and two, your expenses will generally rise faster than you think, especially with children. If you can’t afford the higher amount of insurance, don’t worry. Even a small amount will help tremendously and it’s relatively cheap.
If you’re a stay at home mom or dad, you should also have a life policy. Consider the costs of raising a child and the value you add there. Costs of child care, tutoring, transportation, home care like cooking, cleaning and other duties do not come cheap when hired out. You can use the above method of computing life needs easily for the stay at home parent once you estimate the costs of hiring a caregiver for the children. Don’t cut corners with these costs either, you want your child cared for in the best, most caring environment possible (albeit expensive) especially when one of their parents has recently passed away.
How to buy life insurance (3 tips):
- Try to purchase insurance from independent or non-captive agents instead of dedicated agents. Why? Independent insurance agents have the ability to compare price, product and service amongst a wide variety of insurers. Independents can also sell a policy through another insurer if a primary insurer cannot write the policy. Purchasing through an independent agent allows you to pick and choose the best possible insurance provider & policy with the best possible terms and conditions. This often translates into significant savings in annual premiums.
- Before purchasing life insurance, where insurance companies require detailed medical information about you, see your doctor and close out any open or unresolved medical issues. Insurance companies hate “grey areas”, and they will charge higher premiums for unresolved issues. For example, several years back, a client of mine saw doctor to help with a snoring issue, diagnosed as a possibility of sleep apnea. The doctor recommended the client see a sleep specialist, for which he never followed up. Over 3 years later, the client is applying for life insurance through our firm. The insurance company initially disallowed a cheaper premium for the policy because there was a possibility of ongoing sleep apnea (which is a long term health risk). In fact, the proposed insurance cost rose by more than 60% over the normal rate because the client posed a higher risk, albeit unnecessarily. The client had to return to the same doctor, see the sleep specialist, get the issue resolved, and then reapply for insurance to get the 60% discounted premium. It was worth the hassle, but could have been averted had he cleared this issue up when it first happened.
- Look at the reputation of the insurance company you’re considering. You can easily do this by asking for the ratings. Ratings are provided by AM Best, Moody, Fitch, and S&P. Buy from insurance carriers with ratings in the “A” class. Ratings are important because you really…really want the insurance company to be around, and be financially solvent, when you may need them to be. The old and stodgy insurance company is good here.
Types of Life insurance: Term Life or Whole Life
1. Term life provides the cheapest way to buy a policy. Normal terms are 15, 20, 25 & 30 years. This means that you pay a fixed annual premium for whatever term you choose for a certain amount of coverage. Many clients prefer this because it’s the cheapest form of life insurance. At the end of the 15-30 year term, a client’s personal savings should be able to replace the policy’s face amount. The purpose of the insurance was to protect the family during the “high-risk” years of the insured’s life. The high-risk years are when debt and expenses are high (mortgage, auto, school, college savings, day care, etc.), and income is relatively low.
2. Whole life - (Universal Life and Variable Life) provides life insurance for the insured’s entire life (up to 100), as well as an accumulation of a cash value amount. Whole life is always more expensive because you’re paying for a term policy for your entire life and then the cash value of the life policy if applicable. Premiums can sometimes be inflexible, which may cause problems if you can’t make payments. However, cash values can be used for various purposes such as buying additional smaller policies, paying premiums when you can’t because of a disability or financial hardship, borrowing, etc. As well, we have clients who use their whole life/variable life policies for a tax-deferred savings vehicle. Before implementing, this strategy should be considered very carefully with a professional.
Property & Casualty (Home and Auto) Insurance
Try to consolidate property and casualty policies under one provider. Then ask your broker to inform you of any discounts that provider may offer (good driver, age discounts, etc.) Like life insurance, you should also use a broker, or independent insurance provider to purchase home and auto insurance. This allows you to pick and choose policies that provide the best coverage in the right amounts. Big carriers like Progressive and Geico are fine, but regularly under-insure clients and in the end, the coverage costs about the same. We recommend clients use a property & casualty broker (we refer Heffernan Insurance Brokers) for liability, home and auto. They’ll provide free analyses of home and auto policies and let you know if better deals exist than what you already have.
An estate plan has several elements.
They include: a will, power of attorney, a medical power of attorney (called an Advance Health Care Directive in
Wills - What they are and why they’re important.
No matter what your net worth is, it's important to have a basic estate plan in place. Such a plan ensures that your family and financial goals are met after you die.
Although we generally recommend a good estate planning attorney to develop the above estate planning documents, we sometimes encounter clients with very tight budgets that simply can’t afford attorney’s fees. With good self-help materials (we recommend Nolo Press, www.nolo.com – see the Estate Planning section), it's not difficult to make a will that takes care of basic concerns. Most importantly, the will names a guardian of your choice to take care of your children, as well as someone to manage any property the children inherit. Other actions, such as leaving a home, investments, a small business and personal items to your loved ones is dictated through a will.
Dying without a will - also known as dying "intestate" - can be costly to your heirs because your assets must go through probate court which is an expensive and lengthy ordeal. If both spouses die at the same time, not having a will leaves you no say over who gets your assets. Most importantly, the state courts will decide who your children’s guardian will be. Often times, this takes months, and your children are in limbo during the process.
Advance Health Care Directives
The Advance Health Care Directive (in California) is the document that you draft for yourself that informs and directs doctors and loved ones to do what you want for yourself medically in the event that you are unable to communicate or are incapacitated. Why is this document important? Remember Terri Schiavo’s unfortunate situation? Terri Schiavo was in a complete vegetative state, supported by a feeding tube and life support for over 14 years before any significant decision or action was taken on her behalf. A simple document, as the AHCD is, would most likely have prevented over a decade of suffering, state and federal supreme court hearings, global media scrutiny, and a great number of other problems for the unfortunate family and victim.
Estate attorneys will draft this document (which we generally recommend), however, you can also do it yourselves by ordering a ~$5 copy from the California Medical Association (www.cmanet.org). You’ll need to spend about 60 minutes filling out the form. As well, you’ll need a witness that’s over the age of 18 to witness and sign the document. Do not take the decisions asked of you lightly. Try to think of what you would really want if you were placed in that situation.
Power of Attorney
The power of attorney is generally included with trust documents. The power of attorney document allows someone or a financial entity to take control of your finances in the event that you are dead or incapacitated. We generally don’t recommend you do this one on your own, but using Nolo Press is acceptable. The power of attorney document is important because it’s generally accepted by banks and other financial institutions as a legitimate document that allows the power-holder or agent to take action with the real owner’s accounts. For example: if you were to walk into a bank (where your husband or wife held a singly-owned account) and present the legal will of your wife or husband, they may refuse you account access, even if you really needed the money. However, a power of attorney form would probably be acceptable.
Trusts – they aren't just for the wealthy.
Always use an estate attorney for trust creation.
Trusts are legal mechanisms that let you put conditions on how and when your assets will be distributed upon your death (think of trusts as financial guardians). When applicable, they also allow you to reduce your estate and gift taxes and to distribute assets to your heirs without the cost, delay, and publicity of probate court, which administers wills. Some also offer greater protection of your assets from creditors and lawsuits. Children (generally of ANY age) who receive large lump-sums of inherited wealth generally blow through it within a few years, regardless of how much they’ve inherited.
Summary
You should now thank yourself for taking the time to read this review. You’ve already taken the first small step in providing a lifelong benefit to yourself and your family. If you should need any help in the future, please do not hesitate to call us. Aspire Capital Management provides comprehensive, cost-effective financial planning solutions in the areas of:
· Budgeting & Debt Management
· Investments & Investment Strategy (including real estate investment analysis)
· Estate Planning
· Insurance Services (Life, Health, Property & Casualty, Disability, Long Term Care)
· Education Planning & Funding
· Tax Strategies
· Retirement & Life Planning
We offer a 1 hour free consultation with absolutely no sales pressure.
