Financial Planning

Five Financial Flubs of New Parents

Expecting a new baby? We help you avoid five pitfalls that can harm the financial well-being of your new family.

Babies may not come with an instruction manual, but they certainly come with a crib-load of expenses and responsibilities for the new parents. Unfortunately, money matters often get pushed aside in the excitement of a new arrival. After all, you've got other things to worry about, such as how to survive on an hour of sleep or how to get the baby to stop crying. And besides, who wants to sit down with the checkbook when you could be counting all those cute little fingers and toes?

I know you want what's best for your baby, but not taking your finances seriously -- or even making some well-intentioned decisions -- could actually place your family at risk. So take a moment to set your family up for success from the get-go, and avoid these five money mistakes.

1. Not having a spending plan

Forget diaper pails and bouncy seats. Make sure you have this must-have item number-one: A budget.

I'll be the first to admit that shopping for a baby is fun. But throw in proud papa zeal and pregnant mama hormones and you have a recipe for overspending. Before you lay down a dime, know your needs and wants, and determine exactly how much you're willing to spend -- and from where the money will come. Pick up a copy of Baby Bargains by Alan and Denise Fields for reviews on hundreds of baby products and advice on choosing the must-haves and avoiding the probably-nots. Please, please, please avoid going into debt while outfitting the nursery. Your goal is to create a stable and nurturing environment for baby -- racking up a ton of family debt would do just the opposite.

You'll also need to budget for other startup costs when having a baby, including paying for the hospital delivery and accounting for any unpaid leave you'll take off work. And if one parent plans to stay home indefinitely with the baby, you'll need to make sure you can afford to live on one income and adjust your spending habits accordingly -- preferably before baby arrives to give the arrangement a test run. See Nine Financial Moves for New Moms and Dads for advice on how to stabilize your finances before having a baby. And see Thrive on One Paycheck for tips on how you can afford for one parent to stay at home.

After baby arrives and things settle down to some version of normalcy, you'll need to make sure there's room for baby in your day-to-day budget for things like diapers, formula, clothes, toys, doctor visits, photo developing and babysitters. One way to free up cash for the extra expenses is to pay off your high-interest debt. That way, you can use the money you were spending on interest and monthly payments to cover baby's needs. Plus, you'll probably be spending more time at home with baby than going out on the town, so your entertainment expenses will go down, freeing up more cash. For help in creating a budget, use our budgeting worksheet.

2. Forgoing life and disability insurance

There's much more to caring for baby than warming bottles and changing diapers. You'll want to make sure you're always able to provide for your new family -- even if you should happen to get injured or die unexpectedly. And that means you need proper disability and life insurance.

For life insurance, a good rule of thumb is to get enough to equal four to five times your annual salary. For a more accurate estimate of your needs, though, use this calculator. Even if your spouse works, the added strain to the daily finances may be too much for the survivor to handle in the event of your untimely death -- not to mention the blow to his or her ability to save for the kids' college. And stay-at-home spouses may need their own policy to help pay for childcare in case of their death. Learn more about shopping for life insurance and selecting the right policy for your needs.

Although life insurance is important, you're far more likely to get injured on the job than die. So all new parents should make sure they also have enough disability insurance to pay the bills and maintain their standard of living in case they're ever out of work. You already may have some coverage through your job -- such plans typically cover up to 60% of your salary. Check with your employer to find out if you have any coverage and to get the details. Then take a look at your budget and figure out how much you would need to meet your monthly obligations. Many workers will need to buy a supplemental policy to cover what's left uncovered by their employer's plan. And if your employer doesn't provide any disability insurance, you should buy your own. Learn more.

3. Buying life insurance for baby

Although life insurance for parents is a necessity, you can probably take a pass on life insurance for baby. The main purpose of life insurance is to protect the income of the breadwinner in case of an untimely death. The policy will ensure any survivors can still pay the bills and maintain the same life comforts after that paycheck is gone. So unless your baby is a child actor and you're relying on him or her to put food on the table, he or she doesn't need a policy.

Salespeople may try to peddle the insurance as a savings vehicle, but you can get a better savings rate somewhere else. Or you might hear that baby needs it to ensure coverage in case he or she develops a costly medical condition later in life and can't get life insurance (experts say this would be rare). Your money may be better spent shoring up your own life and disability insurance, or saved in a long-term savings vehicle such as an IRA, 401(k) or 529 college-savings plan.

4. Saving for college instead of retirement

Putting your child first is a natural parental instinct, which is perfectly fine if you're forgoing a personal purchase in favor of a car seat or crib -- but not if it means you'll put off your retirement savings to start up a college fund. Although it may seem selfish to put your golden years ahead of junior's education, it really is smart financial planning. After all, there are loans to pay for school but none for retirement. If you focus all your energy on saving for college, you may find yourself down the road ready to retire without a penny to fall back on, having to rely on your adult child to support you. So, in fact, focusing on retirement first isn't selfish. Ultimately, it's what's best for everyone.

That's not to say you shouldn't save for college at all. A good rule of thumb is to save at least 10% of your take-home pay toward retirement. (Use our retirement savings calculator to see if you're on track to reaching your savings goal, or if you need to up that percentage.) Then, you can funnel any extra cash beyond that into baby's college fund. When you're ready, learn more about the best ways to save for college.

If you save for retirement in a Roth IRA, you can use that as a fall-back account for college savings. Roth IRAs were built for retirement, but the tax rules include provisions that can help education savers in a pinch. You can withdraw your principal from a Roth penalty-free at any time. In general, if you withdraw the earnings before age 59½ you'd get hit with income taxes and a 10% penalty. If you use the money for college expenses, however, the penalty is waived.

Remember, too, that Roth withdrawals will count as parental income and can impact financial aid.

5. Not having a will

Think wills are just for the uber-wealthy? Not so. No matter your financial situation, every parent needs a will to designate a guardian for his or her child just in case both parents die prematurely. Without a will, a court will decide who will take responsibility for raising your child, and you won't have a say. Make sure you designate an alternate, just in case for some reason your first choice isn't able to serve at the time. For more tips, see Guardianship for Your Children from the legal experts at Nolo.

You'll also want to designate who will handle your finances after your death. You may wish for all your assets to pass to your child, but someone will need to handle the logistics. This person doesn't have to be the same person you choose as guardian -- your sister may be great with kids, for example, but terrible with money -- so pick the best person for each job. If your assets are fairly uncomplicated, you may be able to draft a will using software such as Quicken's WillMaker ($40). But for more complicated situations, it's best to consult a lawyer. Having a will gives you a chance to make sure your baby is well taken care of physically and financially after you've gone.

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