Six Critical Financial Moves for Young Families
If you are part of a family with young kids, I bet your life is crazy busy. I get it. But in between carpooling, sports practices, daycare, sick kids, demanding jobs, and everything else, there are six critical steps you need to make sure you have taken care of to put your family on a path to financial success. Here they are at a glance:
1. Make sure you have adequate life insurance
2. Set up a decent emergency fund
3. Contribute to your employer-sponsored retirement plan (at least up to the employer match)
4. Make sure your estate planning documents are in order
5. Get started with a college savings account (even if it's super small)
6. Start a wealth building account
If you’ve got people in your life who depend on your income, you almost certainly need to have life insurance. As a fee-only planner, I do not sell life insurance. I do advise my clients regarding how much life insurance they should have and can refer my clients to trustworthy life insurance providers. Also, we’re not talking about overly complicated life insurance products that most people don’t need. For the vast majority of people, simple term insurance is the best and cheapest option.
At this stage in life, your family is at its most vulnerable from a life insurance standpoint. Your children will likely depend on your income for the next 10, 15, and even 20 years of their lives. I'm guessing you hope your kids will go to college someday. And if you're like most young families, the college fund is just getting started and nowhere near fully funded. All of this would be in jeopardy if you (as the source of their support) were to pass away while your kids are young. The older your kids get, the less life insurance you will likely need (assuming you've been saving and building wealth over time). But in those early years, life insurance is especially critical. The good news is that term life insurance is pretty cheap. Depending on your age and health, you can probably get a million dollars in coverage for less than $1,000 per year. Why so cheap? Because young adults are not likely to die. That’s good news! It's one of those things you purchase and hope you never, ever have to use.
Here’s another basic but critical step: you need an emergency fund. You’ve probably heard this before, but if you're anything like many people I know, you have largely ignored that advice. It’s hard enough to make sure all of your regular bills are paid, let alone save for something like an emergency fund (that you hope to never have to spend anyway).
Despite all that, an emergency fund is important for a couple different reasons. The most important reason is that it will keep you out of credit card debt when unexpected things pop up. I actually separate emergency funds into two different categories:
1. There’s a "true" emergency fund, which will mostly likely only come into play if you or your spouse lose your job, or have some other serious situation
2. Fund for unpredictable but inevitable expenses
The true emergency fund is one you will hopefully never have to touch. Again, it's for those true emergencies such as job loss and serious illness. Depending on your situation, you should aim for 3 months of living expenses in a true emergency fund.
The second kind of "emergency fund" is for "unpredictable but inevitable" expenses in your life (I stole this idea from the book You Need a Budget by Jesse Mecham, which you can buy here). This fund is for all the things you know are going to happen over the course of a year, but you don’t know exactly what will go wrong or how much it will cost. Maybe your car will break down, or your refrigerator will die, or your hot water heater will need a repair. Something will go wrong, and if you've got a fund set up for these expenses, you'll avoid leaning on credit cards when the unexpected (but inevitable) expenses hit. One rule of thumb is to plan to save about 1% of the value of your home for home maintenance and upgrades. So, if your home value is $600k, you might aim to save $6,000 over the course of a year. You could set up an automatic transfer of $500/month to a savings account earmarked for home maintenance and repair. Then pull from this fund when expenses arise. Anything you don’t spend on maintenance can then be saved for longer term for home improvement projects and upgrades. See my post here about automating your savings to help with this.
Contribute to Your Employer Sponsored Retirement Plan (at least to the match)
Most companies offer some kind of retirement savings plan such as a 401k, 403b, or SIMPLE IRA. You can put pre-tax money to these accounts, and they grow tax-deferred. It's a great way to get into the habit of saving for your future, and since the money comes right out of your paycheck, you won't even miss it. And if your employer matches a portion of your contributions, it's a no brainer! Many employers will match up to 3%. If you don't contribute at least that much, you are turning down free money from your employer. Crazy! Eventually you'll probably want to contribute at least 10% of your salary, and hopefully get to the point where you can max out your contribution (currently $18,500 for a 401k or 403b).
OK, here’s another super boring but really important step. You’ve got to make sure your estate planning documents are in order. What do I mean by estate planning documents? Well, the most important one is a will. You don’t need to spend a fortune getting your will set up, but don’t go too cheap either. This is important. A good estate planning attorney will help you set up will, and all the other documents that usually go along with that.
The other important part of estate planning is to make sure the beneficiaries are up-to-date and correct on all of your accounts. So, your IRA accounts, your 401k accounts, and your life insurance policies all allow you to name a beneficiary. In most cases, the beneficiary actually supersedes what is in your will. So you want to be 100% sure that your beneficiaries are up to date.
Start a College Fund for Your Kids
Standard financial planning advice is to not even start your college savings fund until you've maxed out your retirement accounts. As the saying goes, you can always borrow (via student loans and parent PLUS loans) to send the kids to college, but you can’t borrow for your retirement. That’s all well and true. However, I always say that this would only be be great advice if my clients were robots with no feelings or emotions. Here’s the thing -- I meet with families all the time who are trying to balance college savings and retirement. All of them want to do what’s best for their kids, and all of them went to at least have something there that they are building for the kids' future. Maybe they are just putting $50 a month into the account. That’s obviously not going to pay for much college tuition, but it’s a start. It’s something that you point to when you talk to your kids about the importance of college. It's something you can build on year after year, every time you get a raise or have some unexpected windfall. I think starting a college savings fund is just as important for psychological and behavioral reasons as it is for the actual financial reasons. You'll feel better knowing you're making progress even it's slower than you'd like.
To get started and make progress, I almost always recommend that my clients have at least one small college 529 savings account. No need to do anything fancy. If you live in Virginia, there is a great state sponsored 529 plan (https://www.virginia529.com/). See my post here to learn more about 529 plans, especially the Virginia plans. If you live outside of Virginia, there are plenty of good choices as well. The important thing is to just get something set up and start putting a small amount away every month if possible.
Start a Wealth Building Account
Once you're on track with the first five steps, it's time to start a wealth building account. This is a step that many people overlook, but I think it's incredibly important. A lot of people have a retirement account like a 401k through their employer. Some even have an IRA from an old retirement account rollover. But many people don't even think about a regular brokerage account for savings and investing outside of retirement savings. The great thing about an account like this is that it doesn't come with restrictions the way a retirement account does. You can pull the funds out for any reason, which means it's very flexible. You could eventually use the investment account to buy a new car, take on a home improvement project or even send the kids to college. It could be your very own "freedom" or "someday" fund that could eventually give you the freedom and flexibility to quit a job you don't like, knowing you'll have a cushion until you find a better job.
Unlike a tax-deferred account, you will pay capital gains taxes when you sell investments that go up in value, but for most people, the capital gains tax rate is just 15% (and only on the gains). You'll also pay taxes every year on any dividends and interest you receive from this account. Still, I think it's very valuable to have investment savings outside of traditional retirement accounts. If you get into the habit of putting money into a wealth building account every month (again, it's fine to start small!), your future self with thank you!
If you follow these six steps, you will be setting yourself and your family up for financial success. Building wealth takes time. It may feel like you aren't making great progress in any one year, but when you eventually look back on 5, 10 or 20 years of smart financial moves, you'll be amazed at the progress you've made. Here's to your well-planned future!
Disclaimer: This article is provided for general information and illustration purposes only. Nothing contained in the material constitutes tax advice, a recommendation for purchase or sale of any security, or investment advisory services. I encourage you to consult a financial planner, accountant, and/or legal counsel for advice specific to your situation. Reproduction of this material is prohibited without written permission from Alyssa Lum, and all rights are reserved. Read the full Disclaimer.