My wife and I recently welcomed our first child into this world. Wow—what a moment! It was more joyous than we could have ever imaged. As soon as our daughter was born, a feeling of responsibility, unpreparedness and urgency came over me. We knew our life was about to change—forever. What an understatement. Being the financial nerd in our family, I immediately brought out the textbooks and started reacquainting myself with current tax rules and planning situations that new parents face.
There are many different areas of financial planning that all new parents and parents of minor children will eventually have to confront. In order to make this process smoother, you have to prioritize and address the most critical areas first.
Priority 1: Get a Will and Update your Beneficiaries
If you do not have a Will that names a guardian for your child, call an estate attorney to start the process immediately. If my wife and I were hit by the proverbial bus and died, I do not want the state of Georgia deciding how my daughter will spend the next 18 years of her life. Unless you have passed the bar exam, do not draft a Will yourself, as you cannot afford a mistake on this. Most basic Wills run between $500 and $1,000. Even if you do not have a sizeable estate, you still need a Will to legally name a guardian, successor guardian, custodian and successor custodian for your children.
Custodians manage money and guardians make lifestyle decisions for minors. You can name the same person; however, it is possible that the person you name as guardian would be more than capable of caring for your children, but would be terrible at managing their finances or vice versa. Henssler Financial suggests you discuss this scenario with an attorney.
If you have a Will, have a professional review it to determine that everything is accurate and applies to your current state of residency. You should make a habit of reviewing and updating your Will every couple of years.
The second part to this step is to update your beneficiary forms. You do not need to wait until you have completed your Will before you do this; however, I would suggest that you coordinate this with your attorney. Some attorneys do this as they are completing your Will. A common mistake parents make is creating Wills that accomplish one wish, while beneficiary forms accomplish another. The two should be addressed simultaneously. Some accounts that have beneficiary forms include life insurance, annuities, IRAs, 401(k)s and pensions. Remember, these accounts are not governed by Wills. Beneficiary forms and accounts with titles, such as Joint with the Right of Survivorship, Payable on Death, Transfer on Death, and assets already titled in a trust bypass probate and trump a Will. As account titling is very important, a good attorney will ask you about these accounts.
It is generally not a good practice to list your minor child as a direct beneficiary of your property. Minor children cannot legally control property until they are 18, and without a Will, the court will appoint a custodian to manage the property. This unattractive scenario can be eliminated if you name a custodian and successor custodian in your Will. If you elect to name a custodian to manage your child’s inheritance, the custodian will loose control of the property at your state of domicile’s age of majority, generally age 18 or 21 depending on the state (Georgia is 21). Assuming the custodian managed the assets properly and did not misuse the funds, your child will have the full legal right to spend their inheritance as they see fit, once they reach the age of majority.
We all like to believe that our children will be responsible money savvy adults at the age of 18 or 21, but this tends to be a faulty assumption. An alternative option is to establish a testamentary trust, which can be done through your Will. A testamentary trust allows you to decide what age your child can take legal control of their inheritance (e.g., 25, 30, 40, etc.), puts a trustee in charge of asset management decisions, and can offer a lot of other benefits, such as creditor protection.
Do not let the word “trust” scare you. A trust can give a lot more control of your child’s financial future as they are infinitely flexible, relatively inexpensive to create and can be helpful for families of all income levels. Your attorney should be able to help you make the right decisions based on your particular circumstances.
Not addressing these topics could have major repercussions for your child and surviving family members. Consider what is being addressed here: the two of the most dividing and emotional topics in our society—money and children. Do not skirt this issue. As a parent, this should be your top priority.
Priority 2: Review your Insurance
Insurance has a reputation of being boring, and as a result, it tends to get pushed to the back burner. Boring or not, it is extremely important.
Let’s tackle the life insurance first. As a basic starting point, if you do not have $500,000 in individual life insurance, the odds are you do not have enough coverage. If you have group life insurance through your employer, consider this as extra. Do not rely on being employed to cover your life insurance needs. Assuming you are insurable, carry your life insurance personally. The older you get and the more wealth you accumulate, the less you need life insurance. Therefore, we strongly suggest term insurance. Very rarely do families need permanent life insurance. Never buy life insurance for your child. If your agent suggests this, find a new agent.
The neglected cousin to life insurance is disability insurance. This coverage is often ignored, because most people associate disability with work-related accidents or conditions that you have at birth. Car accidents, health problems and an infinite amount of unfortunate occurrences can happen and cause you to be unable to work and earn an income. Becoming disabled will be a costlier drain on your family’s finances than a premature death. Most disability policies only replace 60% of your income no matter how may policies you have, while your cost of living will definitely increase because you have increased medical care. It tends to be expensive to buy on an individual level, so most people are covered through their employers. If you do not have this coverage, call a trusted insurance agent to help you review your options. You need this coverage.
Health insurance is the next major area for review. When a child is born, you have 31 days to add the child to your policy. Prepare for your health insurance premium to increase when you add a dependent. Before the next open enrollment window, take time to review what plans your company offers. The plan you choose needs to fit your family’s medical history and current health care concerns first. Secondly, focus on cost. Read the “Summary Plan Description” that is a federally required document for all group health care plans. It explains what medical conditions the plan covers; what conditions are excluded; what your deductibles, co-payments, co-insurance and out-of-pocket maximum are; discusses your maximum lifetime benefit amount, and many more important plan facts you need to understand. Health insurance can be very confusing. Dedicate a little extra time here so that you receive the most benefit for what you are willing to spend on premiums.
Priority 3: Review your Taxes and Withholdings
When you have a child, your tax equation changes. Uncle Sam has given new parents a few extra tax tools that can help save on our tax bill. What a great uncle!
The first thing you notice is you get an additional personal exemption for each dependent. The personal exemption amount for 2011 is $3,750. The exemption reduces your taxable income by the allowed amount, but is subject to phaseout as your adjusted gross income reaches some pretty lofty levels.
The next little gift you get is a $1,000 child tax credit subject to some limits. This little jewel carries some big fire power. Since it is a credit and not a deduction, it offsets your tax liability dollar for dollar. Alternately, a tax deduction reduces your taxable income; its benefit is equal to your marginal tax rate (e.g., if you are in the 25% federal tax bracket, for every $1 in tax deductions, you save $0.25 in taxes). If you pay for someone to care for your child while you work, you may be eligible for the Child and Dependent Care Credit.
Any time you add or remove a dependent, or your income situation changes (e.g., spouse’s income is reduced to become a homemaker), change your W-4 form and your state withholdings form. There are no limits to the amount of times you can change this form during the year. If you are withholding too much, updating this form will increase your take home pay immediately. Likewise, you do not want to owe at the end of the tax year, as you may be subject to penalties. You do not want to get a big refund check, essentially giving the government an interest free loan. Meet with your tax professional, annually, preferably in May or June, to review your withholdings. This gives you time to file last year’s tax return, collect several months of paychecks, and get a feel for how the current tax year is shaping up. If changes need to be made, it gives you time to make adjustments before year end. This timeframe catches your tax adviser after the busy season.
Priority 4: Start Saving for Your Child’s College Education
Planning for education is important, but only after you have accumulated adequate emergency cash reserves, paid off high interest rate debt, and set aside the necessary amount for your retirement savings. If you think college is expensive, think of what retirement will cost. Imagine going to college for 30 years instead of four. Your primary objective as a parent is to take care of your financial life first, and then help your children build their net worth. There is a reason that flight attendants tell you “in case of loss of cabin pressure, place your own oxygen mask over your mouth and nose before assisting your child.” You are of no use to your child when you are physically or financially knocked out. The worst thing parents can do is put their child in a position to have to financially support them later in life.
There are many creative ways to get a child through college. Perhaps your child will receive a scholarship or qualify for a federal grant or financial aid. You could pay her tuition from your earnings or savings; your child can take out a student loan; a student can work or co-op through college; you can likely withdraw your contributions tax and penalty free from your Roth IRA, or family members could fund a 529 Plan, etc. The point is, there are many ways to pay for college. The only option you have to get through your retirement years is cash. Do not dive head first into college savings plans because you hear everyone talking about how expensive college will be. You need to do an honest financial assessment on your life and goals before college savings plans should show up on your “to do” list.
With these four priorities in mind, you can focus on maximizing your family’s wealth, and in turn, introduce an element of financial stability into your child’s life. If you have any questions or would like more information regarding family financial planning, contact Henssler Financial at 770-429-9166 or at experts@henssler.com
Disclosures
This article is meant to provide valuable background information on particular investments, NOT a recommendation to buy. The investments referenced within this article may currently be traded by Henssler Financial. All material presented is compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. The contents are intended for general information purposes only. Information provided should not be the sole basis in making any decisions and is not intended to replace the advice of a qualified professional, such as a tax consultant, insurance adviser or attorney. Although this material is designed to provide accurate and authoritative information with respect to the subject matter, it may not apply in all situations. Readers are urged to consult with their adviser concerning specific situations and questions. This is not to be construed as an offer to buy or sell any financial instruments. It is not our intention to state, indicate or imply in any manner that current or past results are indicative of future profitability or expectations. As with all investments, there are associated inherent risks. Please obtain and review all financial material carefully before investing. Henssler is not licensed to offer or sell insurance products, and this overview is not to be construed as an offer to purchase any insurance products.
