The Financial Planning Guide for New Parents

If you're a new parent, I'd like to start by saying "congratulations." Words cannot express the elation you feel when you look at the bundle of joy you just brought into the world. You look at your baby and you want to give it the world. The goal of this guide is to lay the foundation of long-term planning that will allow you to do just that.

Disclosure: This article is meant to serve more as a reference guide with general rules of thumb, rather than specific advice for any particular situation. What I mean by that is, you are unique. You have unique challenges, problems, and obstacles in the way of your financial future. It would be negligent to apply general advice to unique situations, and I ask that you read this article keeping that in mind – that this isn’t financial advice, and if you’re looking for specific advice, you should always consult with a professional in the field. Furthermore, a word of caution – your own financial security comes first. Much like the instructions that you receive in an airplane regarding the oxygen masks, “Put yours on first, then your child’s,” the same is true when it comes to financial planning. You may have the best intentions by setting money aside for college, or by paying for your child’s wedding or a car, but what good will all of that do if you fail to adequately plan for your own future, and are financially dependent upon them 15 or 20 years down the line? So if you haven’t read the other guides yet on retirement planning and other matters pertaining to your own future, I would highly encourage you to do so before implanting the ideas herein.

The three areas of planning we will be focusing on are Risk Management, Wealth Accumulation, and Wealth Distribution.

Risk Management is the area of your plan that focuses on Insurances, and Contingency Planning.

Wealth Accumulation is the area that focuses on Education Planning, Major Purchases.

Wealth Distribution is the area that focuses on Retirement Income and Estate Planning.

The steps to getting started are simple.

1. Identify your budget as it relates to securing your child’s financial future.
2. Address Risk Management needs first.
3. Identify your goals for education, major purchases, and inheritance.
4. Establish a plan of savings, with goals separated by time horizon.
5. Execute the plan!

1. Identify your budget as it relates to securing your child’s financial future.

If you’ve laid the groundwork of your own financial plan already, this step is fairly straight-forward and stems from the planning you have already started. If you just had a baby, a simple but imperfect way of determining, for instance, your long-term budget, would be to take your own long-term budget number, and subtract the amount that you’ve already earmarked for retirement. Similarly, you should do the same for the short and medium-term budgets to determine how much money you have to work with.

2. Address Risk Management needs first.

The first areas of planning are ones that no one wants to think about, but are necessary, because emergencies unfortunately happen. The two categories here are Insurances and Contingency Planning and they go hand-in-hand. We’ll start with contingency planning, which means having a Plan B for your child if you aren’t around to take care of him or her. The primary mechanisms here revolve around Wills, Guardianships, and Trusts. As with most legal matters and documents, one should consult with an attorney; in this case, one who specializes in the estate planning field.

A Will is a legal document in which you outline your intentions post-mortem if you are to pass away, often pertaining to the inheritance of property. Even if you don’t have much property yet, you should still have a will because of the guardianship provision.

A Guardianship is a legal relationship between your child and the individual who you designate as a guardian. In case a child’s parents pass away, a properly established guardianship allows the guardian to take care of a child in the same legal capacity as a parent. I strongly advise having a conversation with someone you trust and asking if they are willing to take that responsibility in the event of an emergency. You may also want to have a Letter of Intent, which is an informal letter with instructions on how to take care of your child, his/her preferences and routines, and other helpful information that a caretaker should know.

Trusts are legal arrangements that allow you to leave instructions for how your child accesses the money you leave behind for him or her. Because inheritances can be large, trusts can provide important safe-guards to make sure that the pool of money isn’t abused. For example, a trust provision can state that the child’s financial support is to be limited only to health, education, and general needs, until he or she graduates college with a certain GPA, upon which he/she may access more, or all of the money. One can get very creative here! In establishing the trust, you would appoint a Trustee, someone who ensures that the trust provisions are being followed. If you cannot identify a family member capable of being a trustee, you can always appoint a corporate trustee, although there’s usually some cost associated with that.

In the category of insurances, we will primarily focus on three in this guide: Life, Disability, and Health Insurance. Given the complexity of insurance and varying needs case-by-case, you should consult with a professional in determining the specific types and amounts of coverage appropriate for you and your family.

Life Insurance is the primary mechanism of funding your goals and wishes if you are to prematurely pass away. With life insurance, you designate a Primary Beneficiary who inherits the Death Benefit of your policy upon your passing away. Usually, in a married couple, each individual designates his or her spouse as the primary beneficiary. Life insurance policies also allow you to nominate a Contingent Beneficiary, who would receive the death benefit in the event that the primary beneficiary passes away as well. It’s recommended not to name your children as contingent beneficiaries if they are underage, because they wouldn’t have access to the money until their age of majority; typically 18. If you have a trust in place, it is generally recommended to name the trust as the contingent beneficiary.

Disability Insurance is what pays you in the event that you cannot work for an extended period of time due to a sickness or injury. If you don’t have it already, now is the time to act! Compared to a premature death, disabilities are much more likely, and the financial consequences on a family are typically very impactful. Some employers offer group coverage, typically around 60% of one’s salary as a benefit. If you have that, it’s a good start, but I recommended supplementing it with private coverage to bring the total benefit closer to 90-95% of your salary.

Health Insurance is what pays for hospital bills, doctor’s visits, diagnostic tests, and so on. These medical costs can quickly add up, and health insurance companies are there to absorb the costs and mitigate the impact of what you’re paying out-of-pocket. It’s important for every member of the family to be covered by a health insurance plan, and you can purchase coverage either through your employer or on https://www.healthcare.gov/.

Again, determining the specific types and amount of coverage that you may need is outside the scope of this guide, and one should consult with a professional for advice. Furthermore, other insurances that may be relevant to you but are outside the scope of this guide are homeowners/renter’s insurance, motor vehicle insurance, liability insurance, and umbrella coverage.

3. Identify your goals for education, major purchases, gifting, and inheritance.

This step may be the hardest of all, and you may need to compromise amongst your goals to strike a good balance. Sit down and write out every long-term ambition that you have for your child, and identify the monthly costs of each of them.

A big one here may be education planning, simply due to the sheer cost of higher education. Four years of private college can run over $180,000(1) today, and the costs have been rising at a rate of 6-7% per annum, for decades. Although that trend may not continue into the future, 5-6% is still a very real possibility. To put things into perspective: if a child is born today,18 years from now that cost of education will be $437,982 (using a 5% rate)(2). That’s a large number! But before you panic, keep in mind that investment growth is on your side as well – if you set aside $1,025 per month and your money grows at 7%, you’ll get there! It’s possible that it isn’t within your means to set aside that amount on a regular basis – you may come to the conclusion that you cannot or do not want to fund that amount. Right-size your goals to fit your budget.

My most valuable modicum of advice here is, don’t get overwhelmed. Specifically for education, keep in mind that you have options available – there are tax shelters and incentives, scholarships, financial aid, public universities, and loan programs to help your child afford the cost of higher education. You can do it!

4. Establish a plan of savings, with goals separated by time horizons.

In determining your goals, separate them by time horizon – short-term, medium-term, and long-term. Short-term would apply to any goals within three years, medium-term would be 4-10 years, and long-term would be 11+ years. Returning to the bucket approach, allocate your budget between these three as you see fit.

As always, funding to achieve short-term goals should be kept in cash savings – one should not invest money that can/will be needed within three years. Dollars allocated for medium-term goals can, however, be invested in accordance within your comfort level of risk.

Funding for long-term goals should also be invested with your comfort level of risk, and with tax-advantaged vehicles in mind. There are plans for education funding that can allow you to set money aside for college and allow it to grow without paying taxes on your earnings within the plan, if they are used for higher education. Nobody likes to pay taxes, which is why it is important to work with professionals that can help you plan in a tax efficient manner.

5. Execute the plan!

You can do this! You’ve established the plan, and now you’re ready to execute with the help of some professionals. An estate planning attorney can draft the necessary documents on the contingency/estate planning side of things – wills, trusts, guardianships, and others that aren’t explicitly mentioned in this guide such as living wills and power of attorneys. An insurance advisor can help you right-size your life insurance policy and structure it to work together with your contingency plan. And lastly an investment advisor can help you with the savings and investment strategies to ensure long-term growth of the wealth you’re building. This may seem like a lot of work, and it may be a significant time investment at first, but you will sleep better at night knowing that this chapter of your life is mapped out and your child’s financial future is secure.

Good luck, and don’t be afraid to ask for help if you’re having difficulties on your own!

1) Based on four years at a private university, with a cost of $42,224 per year starting in 2015, with a 5 percent inflation rate. Big Future, The College Board.

2) Based on four years starting in 2033, with costs calculated from 2015 costs ($42,224) with a 5 percent inflation rate. Costs include tuition and fees, transportation, and room and board. Big Future, The College Board, Cost of College Calculator.

Northwestern Mutual is the marketing name for The Northwestern Mutual Life Insurance Company, Milwaukee, WI (NM) (life and disability insurance, annuities, and life insurance with long-term care benefits) and its subsidiaries. Leon Baburov is an Insurance Agent of NM and Northwestern Long Term Care Insurance Company, Milwaukee, WI, (long-term care insurance) a subsidiary of NM, and a Registered Representative and Investment Advisor Representative of Northwestern Mutual Investment Services, LLC (NMIS) (securities), a subsidiary of NM, broker-dealer, registered investment adviser and member FINRA (www.finra.org) and SIPC (www.sipc.org).

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