Parenthood: 5 financial planning must-dos for parents

Roshani Pandey is a financial advisor and founder of True Root Financial. True Root Financial is located in San Francisco, CA and serves clients across the globe.

Natalie is a single mom of her two-year-old adopted son, Nirvik. As a nurse practitioner at a large hospital, Natalie had always been responsible but prior to Nirvik, she had never really planned for the future. As parenthood came into her life, she went from being a care-free thirty-four-year-old to a planner. Once the dust settled from the adoption, she took the following steps to plan for Nirvik’s future.

1. Establish an emergency fund

We all know that you need to have cash in hand for emergencies but the essence of having an emergency fund is to be deliberate about it. This means looking at your expenses and deciding what you absolutely can’t live without and keeping enough cash for those necessities for about 3-6 months.

Natalie looked at her expenses and realized that she was actually overestimating how much she would need. This is common for many and as a result, you end up keeping too much in cash, instead of investing it. This is the reason why it’s important to figure out exactly how much you need.

2. Look into life and disability insurance

Natalie had always had some kind of a life and disability insurance through work. However, she had never really cared about it as she had no dependents. Now, she realizes that as a single parent, her child would suffer financially if something were to happen to her.

First, determine if you even need insurance

If you have no dependents, you may not need any life insurance at all. Even  if you have dependents, you may still not need insurance if you have enough in savings and investments. For example, if you have enough saved in your retirement accounts, you could simply name your loved ones as your beneficiary. If something were to happen to you, that money would automatically pass to them.

Young parents with young children usually need life insurance because they may not have had enough time to save and invest.

What about the insurance you get from work?

Usually, the insurance that you get from work for free is a basic life insurance that might not have enough of a payout at death. Typically, it is also not portable, meaning that if you leave the employer, you will not be able to take the insurance with you.

Natalie evaluates the life insurance she gets through work and realizes that it only has a $50K death benefit, which is not sufficient for Nirvik. She also finds out that it is not portable. So, she decides to get additional life insurance to supplement what she has through work and finds out that there are mainly two types of insurance:

Term life insurance

This type of insurance covers you for a certain period of time like five years, ten years, etc. If you get a term life insurance for five years and name your child as the beneficiary, you pay a small amount of money or premium to the insurance company every month for five years. Your child would get a payout if you were to pass away during that time. If you’re still alive at the end of five years, the policy just expires.

The biggest advantage of a term life insurance is that it is the most inexpensive form of insurance and for most people, it is sufficient.

How do you decide how long the term should be?

This depends on what you are trying to protect. For Natalie, as the sole provider for her son, she wants to support him until he becomes self-sufficient and is able to have his own source of income. So, she decides to get a 20-year term life insurance that provides for him until he graduates from college and starts working. For others, it may be until your spouse reaches retirement age at which point, the retirement benefits might start coming in.

How do you decide how much the payout should be?

Similarly, she also needs to decide how much the payout at death would be. This again depends on what you are trying to cover. For Natalie, about half of her paycheck goes towards paying for Nirvik. So, this is the figure she takes into consideration. For others, it may be different.

Tip: The longer your term and the higher the payout at death, the more expensive the insurance will become. That means your monthly premium will be higher. Remember that for a term life insurance, you don’t get any return from these premium payments. If you’re alive at the end of the term, the premium payments you made are lost. So, don’t overestimate your insurance needs.

Permanent life insurance

This type of insurance covers you for as long as you live. Besides paying out at death, a permanent life insurance typically accumulates some cash value as a result of an investment or a saving component. Because of these features, a permanent life insurance is several times more expensive than a term life insurance for the same death benefit. Additionally, the returns it gives from the investment component is not as attractive and you could potentially do better by investing on your own.

Because of these high costs and lower returns on investments, permanent life insurance is not the best choice for most. However, there are some situations in which they can be useful. For example, they can be advantageous to high-net-worth individuals who are subject to estate taxes. Estate taxes are taxes you pay on what you leave behind to your heirs, above a certain limit. High-net worth individuals typically use life insurance for a variety of tax-planning strategies to minimize estate taxes.

Long-term disability insurance

A disability insurance provides you income in case you are disabled and unable to work. This includes if you are disabled due to illnesses such as cancer or a severe muscle pain. Consider getting a disability insurance at the same time that you get your life insurance.

If you cannot afford a full disability coverage, you may also add a disability rider like an accelerated death benefit rider, to your life insurance.  An accelerated death benefit rider allows you to get some or all of your death benefits if you are diagnosed with a chronic illness that may prevent you from earning an income.

Next steps for insurance

Aim to get three quotes and compare. Natalie decides to get a quote for additional insurance from the same insurance carrier that her company uses. She then compares it with two other reputable insurance carriers. Because Natalie is relatively healthy, she is actually able to find a cheaper rate outside the group rate with her employer.

3. Will and trust

Both a will and a trust give you control over how your assets are transferred after you pass away. When planning for young children, one of the most important aspects of both a will and a trust is that it allows you to appoint a guardian and conservator for your minor children. A guardian is responsible for the overall well-being of your child. A conservator is responsible for their finances. You can name the same person as both.

While a will may be sufficient for most people, a trust may be better for those that are high-net-worth or have complicated assets such as a family business. Read all about why you need a will or a trust and the key differences here.

Natalie decides to go with a will for herself. As she goes down the path of creating a will, she finds that there are additional documents she needs.

What other documents do you need besides a Will?

Durable financial power of attorney

This legal document allows you to appoint someone you trust to take over your finances in case you are incapacitated. Even in ordinary circumstances, this is an important piece of document but when you are the sole provider for your child, this becomes even more important.

Advance directive for healthcare 

This is a a set of legal documents that state your wishes for healthcare in the event that you’re unable to communicate it yourself. Usually, this is when you are medically determined to be permanently unconscious or terminally ill by at least two physicians.

Next steps for will and trust

Consult a lawyer who is licensed to practice in your state to craft a will or a trust and the additional documents described above. If you find that the lawyer fees are too expensive, you could start with an online service such as www.legalzoom.com.

4. Start a 529 college savings plan

A 529 plan is a state sponsored savings account for college, where your money grows tax-free. If Natalie were to open a 529 account for Nirvik, she would name him as its beneficiary. She would then, contribute money she has already paid taxes on into the account. Let’s say she contributed $100K into it and over the years, the money grew to be $150K. Normally, she would have to pay taxes on the $50K.

But in a 529 account, as long as the money is being used for a qualified educational expense, she doesn’t have to pay taxes. So, when Nirvik starts going to college, he can use the entire $150K to pay for tuition, room and board and books without paying any additional taxes.

Read all about 529 plans and how to pick one that’s right for you,  here.

5. Children with special needs

A few years later, Natalie adopts another child. This time, a baby girl named Liling, who has special needs. Liling is eligible for both Supplemental Security Income (SSI) and Medicaid. SSI is a government program to help those with special needs, who also have a lower income. To be eligible for these benefits, however, the applicant or beneficiary cannot have more than $2,000 to their name. This is where a special needs trust and a 529 Able account become useful.

Special needs trust

Many parents want to supplement what their children receive from SSI with additional money to support their children’s lifestyle and healthcare needs. When determining SSI benefits, the government does not take assets in a special needs trust into account because it belongs to the trust and not to the child. So, giving any additional money or inheritance to the special needs trust that benefits your child, can be an effective way to fund your child’s life while still getting government benefits.

529 Able

Similar to a 529 account, a 529 Able account also allows you to save for your child’s education tax-free. However, it has a few more advantages geared towards someone with special needs. In addition to qualified educational expenses, the money in a 529 Able plan can be used for other qualified expenses such as healthcare expenses, job training and financial management. Additionally, the 529 Able plan doesn’t prevent your child from being eligible for SSI benefits and Medicaid, up to a certain limit. Once the 529 Able account has more than $100K, your child may lose their SSI benefits. Additionally, after the death of the beneficiary, the funds in the 529 Able account is subject to be paid back to Medicaid.

Next steps for your child with special needs

Both the special needs trust and 529 Able plans as well as any other planning you decide to do for your child will be interrelated and not just for the child with special needs but potentially for your whole family. Additionally, if you qualify for any government assisted programs, you will want to make sure that you stay qualified.

What does Natalie do?

She looks for a trust and estate attorney who has experience with special needs trusts. The attorney helps her weigh the pros and cons of both a special needs trust and 529 Able plans and also works with her on updating her will to craft a comprehensive plan for both Nirvik and Liling.

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