When you're dealing with bottles, diapers, and sleepless nights, it's easy to put certain things on the back burner -- especially dull and boring things like financial planning. That's why lots of young parents make serious money mistakes -- just when it's more important than ever to get your finances in order. The good news: With just a little planning and attention, you can avoid these common blunders.
You probably already know how important it is to have life insurance to provide a safety net for your children. (And if you don't, you do now: Get to it!) But many conscientious parents don't have the right kind of coverage. "A lot of people are underinsured," says Tim Wyman, a financial planner in Southfield, Michigan. "They don't realize how much their families would need to maintain a similar lifestyle if the main breadwinner died."
A good guideline is to have seven to ten times your gross income in coverage when your kids are young. (If you make, say, $40,000 a year, you should be insured for $280,000 to $400,000.) Stay-at-home parents should have insurance too: Your family will need to provide for the cost of childcare and other expenses if something happens to you. Everyone's needs are different, so talk to a financial advisor or use a life-insurance calculator like the one at insweb.com/learningcenter to gauge precisely how much coverage to buy.
Most financial planners recommend buying a "term policy," which covers you for a set period like 20 or 25 years, instead of a "whole life" policy, which covers you for your entire life as long as you pay the premiums. (Whole life policies are often touted as a good savings and investment vehicle, but they usually aren't.) And term insurance is less expensive: A 20-year policy for $400,000 on a healthy 35-year-old costs about $400 a year, compared with a whole-life policy, which would run roughly $3,500 a year. Unfortunately, many people mistakenly assume that a little insurance for a lifetime is better than a lot of insurance for a temporary period. "It's really not," says Wyman. "It's more important that you have sufficient coverage, at least for the period when your kids are young."
With all your attention focused on your kids, it's easy to forget about yourself. Many new parents stop saving for retirement in order to start a college fund, but that's a serious mistake. "There are loans and grants for college, but not for retirement," says Katrina Miller, a financial planner in Golden, Colorado.
With retirement, how long you save is almost as important as how much -- because the longer you invest, the more you earn. So even a temporary break from savings can jeopardize your financial future. However tight money gets, continue to save something for retirement. (Ideally, young parents should be putting away 10 percent of their household income.) If your employer matches part of your 401(k) contributions, be sure to save at least up to the match; otherwise, you're passing up free money.
Once you've got retirement savings under control, start saving for college, even if it's only $10 or $25 a month. The sooner the better: If you don't start saving until your child is 5, instead of when she's born, you'll have to save 75 percent more every month to get the same total savings by age 18, Wyman says. The best ways to save: a Coverdell Education Savings Account or a 529 plan, both of which offer federal tax breaks on the earnings. You may also qualify for additional tax breaks if you use the 529 plan offered by your state. For more information, visit savingforcollege.com.
Whom would you rather give your money to: yourself or Uncle Sam? If that's a no-brainer, make sure you take advantage of every tax benefit available to you. First, adjust your W-4 at work. Adding an exemption for each new child can put an extra $100 to $250 a month in your pocket, since less tax is taken out. True, if you don't increase exemptions, you'll get that money back as a refund in April. But having the extra cash now could help you stay out of debt while you juggle new expenses like life insurance and daycare.
Next, you need to understand two important federal tax credits: the Child Tax Credit and the Dependent Care Tax Credit. (Remember, tax credits are much more valuable than tax deductions: A $500 tax credit actually reduces your tax bill by $500, while a tax deduction for the same amount just lowers your taxable income).
When you claim a child as a dependent -- which you should do in almost all cases -- you qualify for the Child Tax Credit, worth up to $1,000. (Even if your baby is born December 31st, you're eligible for the whole amount.) Additionally, if you use childcare, you may also qualify for the Dependent Care Tax Credit, which can knock $600 to $2,100 off your tax bill. An important caveat: If your employer offers a Flexible Spending for Dependent Care reimbursement account, which lets you set aside up to $5,000 a year before taxes for childcare, you'll need to make a choice. You can't use a Flexible Spending account and still qualify for the full Child Care Tax Credit. (However, you may still qualify for a lesser tax credit; talk to a tax planner to be sure.)
So, which is the better deal? If your family earns $40,000 or less, it's better to skip the flexible spending account and take the whole tax credit. Higher-income families, however, will likely do better with the flexible spending account.
No one wants to think about dying, especially when you've got a baby who depends on you so completely. But if you don't write a will and create a trust, your children may end up in financial, as well as emotional, distress if you die prematurely.
The number-one reason you need a will: So you, not some judge, get to name a guardian for your children. "I've seen many horrible battles between grandparents, friends, and other family members over custody of a child," says Robin Giles, a financial planner in Laguna Niguel, California. "It would be much better to make your wishes known while you're alive."
It's also critical that you establish a trust that specifies how and when your children will get their inheritance, and allows you to appoint a trustee to watch over the money. Without a trust, your children will have access to your entire estate at age 18. "That's too much money, too fast, too soon," says financial planner Chris Cooper, of Toledo, Ohio.
It's best to consult with an attorney to create a customized will and trust. Too time-strapped? That's no excuse: Make a DIY version with Quicken WillMaker Plus.
When you're up to your eyeballs in diapers, Desitin, and the demands of a newborn, who has the energy to balance the checkbook? But tough as it is, you need to find time to stay on top of your money. "Just as you need to babyproof when you have kids, you need to keep your financial house in order too," says Cooper.
First and foremost, that means making sure that you spend less than you earn -- especially if you've scaled back on your work -- and reining in the impulse to lavish the baby with extravagant gifts. "The expensive crib and the bedding and the perfect bedroom is all about you," Miller says. "The baby doesn't care."
Experts agree that it's very hard to catch up again once you've gone into debt. "So many new moms cut back on work, and then refinance the house or borrow against their 401(k), thinking it's temporary and that they'll make it up later," says Miller. "But then they discover, there is no later."
It's also important for stay-at-home moms to pay close attention to the family finances. "A lot of women don't feel entitled to make money decisions when they're not earning income," says Mary Claire Allvine, a financial planner in Atlanta. "But it's important that both partners stay closely involved to make sure you're both making the kinds of financial choices that will help you achieve your long-term hopes and goals."