One of the things I enjoy most in working with hundreds of client families is the overwhelming joy experienced when they bring a child into this world. It’s difficult to put into words, but there is something about a newborn baby that refocuses and reminds us of what is truly important. For new parents however, the overwhelming joy is often accompanied by overwhelming stress and responsibilities as it pertains to financial matters. I recently sat down with my partner, Marshall Clay, who had his first child not too long ago, and asked him to offer his top three pieces of advice for new or prospective parents.
1) Establish a Budget
Prospective parents should analyze how they are spending their money and establish a budget. The first step in this process is breaking down expenses between what is necessary (fixed) spending, and what is not necessary (discretionary) spending. Once fixed spending is established, you can then trim the fat on your discretionary spending if your expected need is more than you anticipated, which will most likely be the case! Some of the big-ticket fixed costs associated with newborn children include healthcare, childcare, food, clothing, and diapers. While this list is not all encompassing, it gives prospective parents an idea of the financial obligations to come. The good news is that, at least in the short run, discretionary spending in areas such as travel, going out to dinner, and general entertainment will likely drop off dramatically until the parents get comfortable with having a new baby in their life.
2) Eliminate Risks with Life and Disability Insurance
Young people often think they are invincible and overlook the risks of death or disability. One way to reduce, or eliminate, the risks associated with these negative outcomes is to purchase insurance. While there are many uses for life insurance, most use it to offset the potential loss of income in the event of death. Disability insurance, on the other hand, does not protect against the loss of life, but the loss of income due to injury that prevents work.
Life Insurance: For life insurance, a typical rule of thumb is to purchase enough to cover all outstanding debts and provide a satisfactory annual income stream for your dependents. For example, if you have $500,000 in debt and your family needs $50,000 per year to cover all expenses, you may need upwards of $1.5 million in insurance. This would cover the $500,000 in debt and assuming an annual growth rate of 5% on the remaining $1 million, you would have your $50,000 per year cash flow stream. While additional insurance may be needed if you are looking to provide for a higher quality of life, or needs such as education, weddings, etc. The example above gives you a good starting point.
Disability Insurance: For disability insurance it is a bit more straightforward as it is used purely to offset the loss of income due to injury. Many employers offer affordable group policies, so explore that option before looking at the private market. Policies are typically broken down between short and long-term plans, so make sure to have both if possible. Additionally, most insurers will only cover an insured up to approximately 70% of their average income and cease benefits between the ages of 65-70. Lastly, if you happen to work in a specialty field, make sure the insurance provides coverage in the event injury leaves you unable to return to your specific profession.
3) Execute a Will
For parents a Will is an absolute necessity! One of the most important aspects of a Will is determining who will raise, and financially care for, minor children in the event both parents die prematurely. Without a Will parents are essentially delegating this decision to the court system, which will almost certainly not line up with the parents’ wishes. The other major consideration is how any assets left to the children will be passed to them later in life. While young couples may feel they do not have substantial assets to pass, when life insurance is added to the equation, their thoughts often change. Couples leaving substantial assets should ensure these assets flow to children in a way that provides for their wellbeing, but also protects them from themselves (i.e. bad financial decisions) and from others (i.e. creditors, lawsuits, predatory spouses, etc.).
Thanks for your advice Marshall!
Children add so much joy to our lives, but also bring with them new responsibilities and challenges that must be met. If you, or someone you know, is a parent, or prospective parent, ask them to consider the advice above so they can focus on what is truly important, which is loving the new addition to their family.