Nobody needs to be told that babies are expensive. Numerous organizations publish regular reports revealing the average cost of raising a human from infancy to independence, and there are online calculators, too -- but those figures are frankly nonsensical. It's not a case of your mileage may vary, it's a case of your mileage will vary. How much? Well, however much you can afford, figure it'll probably be about 10% more than that. But that's life -- literally. All of which leads to the inescapable conclusion that most of the mamas and the papas could probably use all the help they can get when it comes to setting up their finances for parenthood. So for this Motley Fool Answers podcast, cohosts Alison Southwick and Robert Brokamp have invited a special guest to help them dole out those details: Dan Messeca, a financial planner with Motley Fool Wealth Management (a sister company of The Motley Fool).
In this segment he sets out the first personal finance tasks that parents should handle after having a baby: dealing with the uncomfortable topics of their own mortality, estate planning, and ensuring that your children are well taken care of in case the unthinkable happens.
A full transcript follows the video.
This video was recorded on March 12, 2019.
Alison Southwick: Yes, you are a new father, so you are going through a lot of this personally. And, as a financial planner, you've also helped a lot of people navigate having a baby and beyond; I mean, because, boy...
Robert Brokamp: It's just the beginning, buddy! [laughs]
Southwick: Oh ho ha ha! Cool! So let's get into it! First we're going to talk about what the fun side effects are of having a kid, and that is that your own life suddenly goes up in value. You're suddenly a more important person because you had a baby.
Dan Messeca: To someone.
Southwick: To someone, yeah.
Brokamp: Not to everyone. Just to someone.
Southwick: No, just to someone. So let's talk about how you need to value your life a little bit more.
Messeca: I think the first thing that we did -- which is easier from the perspective of a financial planner because we do it every day -- was to talk a little bit about our own deaths.
Southwick: So fun!
Brokamp: Yes, the arrival of a new life makes you think about your own death.
Messeca: Right, it's something to measure how close that's coming by. The first thing we did was talk about what happens when we're not around anymore. And to do that, you really start looking at estate planning, life insurance, and generally talking about what would happen if we were to be gone. From a formality perspective, finding an attorney who can work with you to draft up some estate plans. Wills if you don't have them. Updating beneficiaries on accounts.
Southwick: For what accounts?
Messeca: On IRAs. If you have life insurance already, you want to look at that. If you don't have it you'll want to apply for it, because that can take some time. Making sure you get the right amount in place.
But from a different perspective, I think one thing I did not think a whole lot about -- in the process of updating wills and getting trusts in place -- was who's going to be the guardian to your children. The guardian and the person who makes the financial decisions can be separate people.
That was sprung on us in the middle of a conversation and I think fortunately we had people in mind to fill all those roles. That's something probably worth talking about before you march into an attorney's office and start putting things to paper.
Brokamp: The people who may be good surrogate parents to your kids may not be the best at handling money. Those are two separate skill sets.
Southwick: So what are different ways that you structure that, because if someone is looking after the kids, then they obviously need money to take care of the kids. How does that relationship work?
Messeca: You want people who can work well together, because they will have a relationship in managing those decisions. But the way it was framed to us -- and I think it makes a lot of sense -- is just to have an outside perspective to make sure that those funds are being put to the right use and the use that you would want it to be, rather than just having someone who might not be so good with money themselves, or might not be able to prioritize in the same way that you want.
We had a couple of our cousins who filled those roles for us. We felt like they would be nice counterbalances to each other. But that never would have crossed my mind, honestly.
Southwick: So you do have it set up so that one cousin is managing the money and one cousin is taking care of the kid?
Southwick: Oh, really?
Southwick: And they're cool with that.
Messeca: Yes. They signed up for it. Hopefully it doesn't come to that.
Southwick: Hopefully it never comes to that, of course. So update your will and estate plan. Thinking about the guardians, but also who's going to handle the money. Let's talk a little bit more about purchasing life insurance, because for us, personally, it got weird. I didn't like the guy that we went to go talk to about it. He wanted us to purchase a ton of life insurance that I didn't feel is necessary, but maybe, why not go err on the side of tons of money?
Messeca: The question of who you see is a good one, because that can take a lot of different forms. A life insurance salesman is going to make money when you buy life insurance, and his pay is going to depend on how much you buy. But I think when you are seeking out a policy you know that already. They've got to make money and you need a service, so it's a good fit.
As far as what type and how much, the way to frame it is if something were to happen to you, what would be lost and what would need to be replaced? If I were gone, my wife would still need to raise the children. Pay for all the things that are happening. Her ability to work may be impacted, so if she's going to have to stay home longer, how do we replace that income? Or if she won't be able to stay home, how can she afford the additional care that's needed?
There's a lot of formulas that are in place that might help you get there, but I actually think it's more of a personal review than just fitting into some formula.
Brokamp: Do you generally go with the "buy term life insurance" school?
Messeca: Yes. If we're looking at covering the need of a child, then I do go by that method. You want to make sure you have enough money to get your kid to maybe not total self-dependence, but close to it. Getting them out of school. Out of college, perhaps. Twenty years is a good time frame. Or if you're a great saver, maybe you can do less.
Brokamp: We did 20 years once our kids were born.
Southwick: 20 years of what, though?
Brokamp: Of term life insurance.
Southwick: So it would pay out for 20 years? See, I don't know the basics of life insurance. Help me!
Brokamp: That's a great question, Alison!
Messeca: That is a good question!
Brokamp: You pay the same premium every year for 20 years and you maintain that same coverage unless you change anything.
Southwick: So you will be paying for that for the next 20 years. Then by the time you are 60 or 70, then you stop paying life insurance because at that point you're not making any money anyway, so it's not like you're replacing any lost income. Is that the thinking?
Brokamp: Right. My thinking was along the lines of what Dan said, and that is basically around the time they're in college, if something happens to me after that, they're going to probably be OK. I just want to make sure my wife has money if something happens to me before then.
Southwick: But do you get to that number based on your income? Or do you get to that number based on your expenses?
Brokamp: That's a good question...
Southwick: I'm full of good questions!
Brokamp: You're just full of it. So I'll just give my answer.
Brokamp: There are lots of tools on the internet that will allow you to do that. I'm sure Dan uses some financial planning software that is more sophisticated that could help you arrive at that. There's also a classic rule of thumb of 10 times your salary, which I think is actually a pretty good starting point. Am I about right on that?
Messeca: Yes, 10 times salary is the easiest one, and I'm all for the path of least resistance when it goes to making financial decisions. If you didn't want to go calculate everything item by item, if you're at 10 times salary, you're probably in a good spot. It gives you 10 years of buffer to figure out what you have to do after that if everything else goes to...I heard Sean cursed on this show. Is that on the table?
Southwick: Did we beep it?
Messeca: You did. It was my favorite moment on the podcast.
Southwick: I don't know that Sean made a lot of friends with our episode when he was on. He came strong to the hoop.
Messeca: He made one friend, because I liked hearing about the edit.
Brokamp: There are a couple of other important things to know about life insurance. First of all, it's tax-free, so that's good to know you're getting all that money. And also the survivors will still get some Social Security, as well. So if you were to pass away, [your survivors] won't have to rely just on life insurance.
But the term "insurance," especially for a new parent -- let's assume you're around 30 years old -- if you're healthy, you want a $500,000 policy. It's only going to cost you $200-300 a year. And I would say $500,000 is probably not enough for most people. You shouldn't really skimp on it. To move that up to $1 million would cost you less than $200 a year. You might as well. It's good investment, because the difference between having a life insurance policy of $500,000 vs. $1 million when someone dies could make a world of difference.
Southwick: And the last one was updating your beneficiaries. As we've talked about on the show before, what you have in your will still gets trumped by who you have as your beneficiaries on different accounts.
Brokamp: The laws vary from state to state, but at the very least it causes problems if your life insurance policy, 401(k), or IRA says it's going to this person but your will says no, it goes to this person.