Expert advice on insurance, writing a will, college savings and much more.
When Jennifer and Justin Stanton (not their actual names), both 35, of Boston, were expecting their first child, they spent most of their energy setting up the nursery, sifting through baby names and reading about infant care. Like most new parents, they didn’t give much thought to one of the most important issues facing new parents: their finances.
But now, with daughters ages two and eight months, they realize that focusing on the short-term delights of raising kids and ignoring financial issues puts their family’s security at risk.
Getting started on a financial plan, however, isn’t easy. The many complex money matters that become part of the lives of new parents are overwhelming. Some of the biggest issues the Stantons face include: what to do to ensure that their family will be taken care of if either becomes disabled or passes away prematurely; how much to invest for their children’s college costs; what to have in an emergency fund; and whether their savings are invested properly.
The Stantons are grappling with financial challenges as they go from being a two-earner household to one. “I left my job after having my second child this is the first time we’ve ever tried living off one salary,” says Jennifer, who worked in the public health sector.
To help the Stantons get on track, Malcolm Makin, a financial planner in Westerley, RI, analyzed their finances and came up with a plan. Here’s a look at how the Stantons measure up on the most critical financial issues, and what they should do to put themselves on track for long-term security.
Jennifer and Justin each have term life insurance, which is a kind of policy that stays in effect for a period of your choice — in their case, 20 years. The insurance expires after the term is up, or if you stop paying your premiums.
Justin’s coverage is three times his annual salary. Jennifer has a $300,000 policy.
“Do we need more coverage?” Justin asks.
ADVICE Yes, Makin says. While Jennifer’s policy is sufficient to provide care for the children should she die prematurely, husband Justin is “grossly underinsured.”
He should increase his coverage to about ten times his annual salary, Makin suggests. “The good news: Term life insurance is cheap, so it shouldn’t be a burden to fully insure yourself.”
A 20-year $500,000 term policy for a man in good health runs about $20 a month. If you buy it through an employer or trade organization, it’s often cheaper.
The idea behind term insurance is to provide coverage during a family’s most vulnerable years — before the children have graduated from college. Other kinds typically combine an investment component with the death benefit, and monthly premiums are thousands of dollars.
Justin thinks he may have some coverage through his employer, but hasn’t checked out disability insurance.
ADVICE Disability insurance is the most underrated financial tool. “At age 35, you are seven times more likely to have a disability interrupt your income than death,” Makin says.
Some states offer residents disability payments, and many employers provide coverage. “Find out what you’ve got, and crunch the numbers to make sure it’s enough,” Makin suggests.
If, like the Stantons, you have enough savings to cover you in the short term, look for long-term disability insurance. Avoid policies such as one that promises to pay you money back at age 65, Makin says. “Your premium will be higher. Pay as little as possible through a reputable company.”
WRITING A WILL
The Stantons have no will.
ADVICE Writing a will and appointing guardians of your children are essential, Makin says. If you don’t name a guardian, a court would. Makin suggests naming an individual, rather than a couple, who might divorce.
Creating a will is quick, easy and cheap. You can use downloadable software, or hire an attorney at $200 to $400.
Jennifer and Justin have about two months’ expenses in an emergency fund. Their bank savings account earns a two-percent interest rate.
ADVICE Put more fluff in the cushion. Makin recommends keeping at least three months’ expenses on hand to cover unexpected costs.
“The money doesn’t have to sit in a savings account, though,” he says. “It can be in a money market fund or in short-term treasury bonds earning more interest — you just have to be able to get it if you need it.”
For this money, avoid investments in which you risk losing part of your principal if the markets tank, such as stocks or bond funds, he says.
The Stantons have homeowners’ insurance on their two-bedroom condominium. So, are they covered?
ADVICE Theoretically, yes. But they could go further to protect themselves in the event of a fire or other disaster. “Make an inventory list and take pictures of everything you own of any value,” Makin says. With documentation, an insurance company is likely to settle with you quickly and without great debate over the payout.
The Stantons have researched college savings options, but have yet to put away their first dollar.
ADVICE Makin recommends a 529 plan, which lets you invest your money and withdraw it tax-free as long as you use it for college costs. Your contributions are invested in a portfolio that gets more conservative as your child nears high-school graduation. If your child doesn’t go to college, you can use the savings for another family member.
Each state sponsors its own 529 plan. While you may get a state tax deduction and lower fees if you invest in your own state’s plan, “it can still pay to shop around,” says Joseph Hurley, a financial planner in Pittsfield, NY, and founder of www.savingforcollege.org, which details college-savings options. “There are significant differences among plans.”
For example, annual fees on 529 plans are all over the map, ranging from .40 percent to 2.8 percent. And some plans are more conservative than others, meaning they hold more bonds than stocks compared to other portfolios.
The Massachusetts plan, the Stantons’s preferred plan, doesn’t offer state tax deductions or credits for residents, but it has reasonable fees and a fairly aggressive portfolio, which suits them.
But they can do even better elsewhere. Chris Cordero, a financial planner in Chatham, NJ, who has analyzed 529 plans extensively, suggested either the Utah or Michigan plan. Both are dirt-cheap, with Utah’s expenses .38 percent and Michigan’s at .45 percent. While Utah’s is slightly cheaper, Michigan’s is more broadly diversified. Along with a mix of domestic and foreign stocks it holds real estate and bonds that are indexed to inflation. “They won’t go wrong with either plan they are the best two in the nation,” Cordero says.
Jennifer and Justin are diligent savers, with more than $200,000 in four different 401(k)s. Three are from past jobs, and one is through Justin’s current employer.
The money is invested in a super-aggressive manner, with 90 percent in stocks and 10 percent in bonds. Of the stock portion, 18 percent is in international securities and the rest is spread across small, medium and large U.S. companies.
Justin is currently contributing just less than the maximum allowable to his 401(k) — $15,500.
ADVICE Jennifer and Justin have done a commendable job saving so far, Makin says. A 401(k), 403(b) or other tax-deferred retirement plan is the first place to put savings dollars, “because you get the most mileage on your money in those accounts,” Makin says. They let your money grow tax-deferred, and in many 401(k)s, you get the added benefit of an employer matching up to six percent of your contributions. “That’s free money,” Makin says. Even if you can’t put in the maximum, at least put in enough to get the full employer match.
Like Jennifer and Justin, folks with more than a decade to go before retirement should invest primarily in stocks between 70 and 90 percent is wise. The more you put in stocks, the more your money will grow over time.
You’ll get your best growth in stocks. While a stock-heavy portfolio’s value will swing in the short term, you can temper your volatility by spreading your money across different kinds of stocks. Here’s where the Stantons need to do some homework. Makin suggests that they increase their exposure to international stocks to about 25 percent.
What’s more, Justin should bump up his contributions to the maximum allowable level, and consolidate their accounts. Makin suggests transferring assets in their inactive 401(k)s into IRAs, which are tax-deferred accounts that can be opened through a bank, brokerage or mutual fund. “There’s no reason to pay plan fees,” Makin says. “And if the money is in IRAs, you have full control over it. In the 401(k)s, you can only invest in mutual funds the plans offers.”
Karen Hube is a freelance writer in Westport, CT.
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