Family Finance Crash Course
Will your bank account survive parenthood? Don't let baby make you broke!
Starting to Build a Safety Net
First comes love. Then comes marriage. Then comes baby in a baby carriage -- and a swing and a dozen diapers a day. It's enough to stretch your budget to the breaking point. On top of these new expenses are the myriad financial "must-dos," from buying life insurance to saving for college, that you've heard about from friends and family. Just thinking about this financial to-do list is almost as overwhelming as taking care of your newborn. So what task do you tackle first? We've simplified matters by boiling everything down to five steps in their order of importance.
1. Buy Life Insurance
Job one for every parent is ensuring the safety of the children. That means getting life insurance, which will pay a chunk of money to your survivors should you go before your time. "A lot of parents I know just keep putting off buying life insurance," says Alexandria Cruey, of Norwalk, Ohio, who has a 9-month-old son. "But it's hard enough to raise a kid on two incomes. I can't imagine doing it alone." There are many life insurance options, but for 99 percent of new parents, term life makes the most sense, says Bob Hunter, director of insurance for the Consumer Federation of America. It covers the insured person for a period of time and pays a benefit if he dies during that term.
You'll need to decide how much money your heirs will receive if you die. To come up with that figure, multiply your annual income (or, for a stay-at-home parent, the cost of replacement childcare) by the number of years you want to provide financial support. "For a sole breadwinner who wants to cover the family for the long term, a good approach is 10 or 12 times the salary," says Steve Weisbart, an economist with the Insurance Information Institute. For a two-income family, five to eight times for each parent might be enough.
It's a good idea to decide how long you want to be insured and to lock in a fixed annual price for that period so your premiums won't increase annually. If you have a baby, a 20- to 30-year term means that your child will be on his own when the policy ends.
How much is all of this going to cost? A healthy 30-year-old nonsmoker can expect to pay about $350 per year for a 30-year policy worth $500,000, or $500 a year for a $1-million policy. If you have a special-needs child who will remain a dependent for your life and beyond, you might consider whole life insurance, which provides coverage for an individual's whole life rather than for a specified term. Included is a savings component, called cash value or loan value, which also serves as an investment tool. (For more information about whole life insurance, go to iii.org/individuals/life.)
Whatever plan you choose, shop around for quotes from both independent agents and insurers, and buy from a solid company that will be around for the long term. Check out any insurer's financial-health rating at ambest.com.
Getting Rid of Debt
2. Eliminate Credit Card Debt
Once you've protected your children for the future, it's time to think about getting your finances healthy for the present, and that means getting rid of credit card debt. Your main goal after paying your bills should be paying off the cards as fast as possible. Otherwise, the interest costs will be an ongoing drain on your budget.
For example, if you owe $8,000 on credit cards with typical interest charges (about 16 percent) and pay only the minimum balance each month, it will take you more than 40 years to pay off your debt; and you'll spend more than $15,000 in interest payments along the way. But increasing your monthly payment by just $40 over the minimum amount due each month, which in this example would mean paying about $200 every month, would drop the payback time to less than five years and your total interest costs to $3,500: an overall savings in interest costs of nearly $12,000.
That's why it's so important to send as much money as you can with each month's payment, even though it may mean you can't build up your savings. It may also make sense to consolidate your debt into a single loan, since you'll get a lower interest rate. But make sure that the new loan has the shortest term you can afford, says Tracey Blaue, director of education for the Consumer Counseling Credit Service, of Springfield, Missouri. "Don't just use the lower interest rate to get a lower monthly payment," she says. "Use it to shorten the loan, and keep paying as much as you can each month."
Setting Up a Budget
3. Set Up a Budget
Here's how to manage your cash flow effectively and wisely:
- Tally your monthly expenses for the previous year. Use a computer program such as Quicken, or look through your check register, utility bills, and credit card receipts to come up with an average monthly amount spent on mortgage or rent, groceries, utilities, your car, insurance, entertainment, and all other recurring expenses.
- Add in the costs of your baby, which you can estimate at about $400 per month, according to Alan Fields, author of Baby Bargains (Windsor Peak Press, 2005). "That's just for diapers, clothes, gear, and other supplies," he says. Your healthcare premiums are likely going to increase, as well; and if you'll be paying for childcare, you'll need anywhere from $400 to $3,000 per month for that.
- Now look at your average monthly take-home income after taxes and other deductions. If your expenses are higher than your income, you've got some paring to do. "Look for things you can do less often or do without," says Beth Remnick, a certified financial planner in Falls Church, Virginia. "Maybe you can get your hair done 6 times a year instead of 10 or go out to eat less often." Or maybe you'll need to eliminate costly vacations or hobbies. If you just can't get there, it may be time to think about ways to increase your family income, such as looking for new employment or taking on a side job. Keep at it until you've got a comfortable margin that allows you some wiggle room and ideally also lets you contribute some cash to a savings account.
Budgeting for Baby
You already know it's cheaper to buy diapers in bulk. Here are a few ideas that you may not have thought of:
- Shop with an expert: When it's time to shop for your new baby, bring along a friend who has a baby. She can say, "Buy the bouncy seat, skip the fancy crib bedding."
- Barter for babysitting: Set up a free babysitting exchange where you watch a friend's kid one night and they watch yours another.
- Spend tax-free: Many employers offer flexible spending accounts that allow you to set aside some of your earnings untaxed for certain expenses. You can put as much as $5,000 into a childcare spending account or medical savings account respectively.
- Save creatively: When you get a rebate check or cash in a jar of change, put the cash in your savings account.
- Borrow from friends: If your friend has a baby who just grew out of her bassinet and you need one, ask if you can borrow it.
Planning for the Future
4. Build a Financial Cushion
With debt under control and a budget in place, it's time to think about building up a savings cushion. "When my husband was laid off from his job, our savings saved our lives," says Wendy Nobles, a mother of four in Dallas, Texas. "We could pay our bills and buy baby things without going into serious debt."
Financial experts often recommend socking away three to six months of living expenses. But let's face it, that's just plain unrealistic for many new parents. Save what you can by contributing a cash allotment each month (say, $50) to a safe place.
Chartered financial analyst Bob Bilkie, of Southfield, Michigan, recommends an online savings account; you can find one at ingdirect.com. "They currently pay 3 percent interest, which isn't bad for an FDIC-protected account," he says. There are no ATM's, so it's not easy to grab the cash, and no fees or balance requirements. All account activity is handled online by transferring money between the Internet account and your existing bank account.
Saving for (Gulp!) College
5. Start Saving for College
Once you've established a comfortable savings cushion, you can begin to allocate some of your monthly savings toward a college tuition fund. The bad news? By the time your child graduates from high school, four years at a private college or university may cost you more than $250,000; and public tuition may reach $140,000.
Those are big numbers, but you won't have to pay it all out-of-pocket. There are loans and financial aid to help you out. You can invest your money in a mutual fund account, where it can grow until your child reaches college age, or you can choose a plan designed for those big bills:
- 529 accounts: With one of these programs, your college fund can grow tax-free. Every state has its own 529 program, and you can enroll in any one no matter where you live. Look for a program that offers an age-based allocation fund, which is a broad-based mutual fund that starts out with aggressive investments and gets more conservative as college gets closer.
- Prepaid tuition plans: This option allows parents to beat tuition inflation by paying for college now. You pay today's tuition on a payment plan, and then your children go to an in-state public school when the time comes.
Still stymied by all of your big, scary new responsibilities? Don't be. The more practice you have at parenting, the better you'll be at tackling any to-do list, financial or otherwise.
Josh Garskof, the father of two sons, is a writer living in Fairfield, Connecticut.
Originally published in American Baby magazine, September 2005.