When it comes to financial planning, parents of young children face a number of difficult choices, including how to pay for their children's college without ignoring their own long-term savings goals. Here are 10 mistakes to avoid.
Editor’s Note: Modera Wealth Management’s Kelly A. Henning, CFP, recently gave a presentation on common financial planning mistakes made by parents of young children to the Pascack Junior Woman’s Club at its monthly meeting in Park Ridge, NJ. She has reformatted that presentation into this list, in order to share it with readers of this blog.
The most common financial planning mistakes include:
1. 529 plan confusion. Saving in a 529 plan can have tax advantages due to the ability to use funds for qualified educational expenses in the future without owing income tax on the withdrawals. Some parents invest in the 529 plan offered by their own state by default. Each state offers its own 529 plan, but you do not need to live in a certain state to enroll in that state’s plan.
Some states offer income tax deductions for contributions to the plans. New Jersey, however, does not offer a state income tax deduction. If you live and work in New Jersey, you may want to consider some other state’s 529 plan. If you live in New Jersey but work in New York, it may make sense to consider contributing to the New York 529 plan to obtain the state tax income deduction offered there.
One factor to consider when choosing between plans is expenses. When looking at 529 plans, we like to see that management fees are under 1%. A financial advisor may help you determine which factors are appropriate for your own consideration when selecting a 529 plan.
2. Lack of estate planning documents. If you do not have a will, you may be leaving the guardianship of your children and the division of your assets up to the courts. Probate court can take a long time to assign guardians and beneficiaries, and while each state has its own rules and regulations, children can potentially be shifted from one family member to another until things are sorted out.
In addition to a Last Will and Testament, important documents for estate planning include living wills and healthcare directives. If you should become incapacitated, who would you want to make medical decisions on your behalf? One famous case involved a woman who remained on life support for over a decade while members of her family fought in court over her outcome.
3. Not updating beneficiary designations. While your will provides guidance on the division of your assets, it does not apply to your employee retirement accounts. As such, it’s important to make sure that those beneficiaries are updated. For example, a second wife may be unable to inherit the retirement accounts of her late husband if he failed to update his beneficiary forms. There have been cases of people who had listed their siblings as beneficiaries before they had children of their own, but forgot to update the designations later on once their children were born.
4. Overlooking disability risk concerns. There is a greater chance of being disabled than of passing away during one’s career, yet many people overlook disability risk. We sometimes also hear people mention that they are covered by their group plan at work, but they do not know the policy details. A policy may cover “any occupation” or “own occupation.” Most group plans are “any occupation,” meaning you cannot claim disability benefits if you can perform any job at all. For example, if you’re an accountant but you get disabled, you can’t receive benefits if you could still perform the duties of a minimum wage job. “Own occupation” means that you may be entitled to benefits if you cannot perform the job duties of your current occupation.
5. Focusing on college savings more than retirement. Parents of young children often try to save for their children’s education and their own retirement at the same time. It can be challenging to decide how much to save toward each goal. We often tell our clients you cannot take out a loan for retirement, but there can be federal and private loans available to parents and children to help finance college education.
6. Lack of life insurance on a non-working spouse. Many parents are quick to insure the life of a working spouse but have no life insurance on the non-working spouse. Life insurance benefits can help pay for child care, household operations, and other expenses that might arise on the death of a non-working spouse. It’s also important to keep in mind the increasing cost of college along with the amount of monthly mortgage payments and other fixed expenses when determining your insurance needs.
7. Overlooking umbrella insurance. An umbrella policy can provide an additional layer of liability protection beyond the underlying coverage (typically between $100,000 and $500,000) from homeowners and automobile insurance policies. For example, if you were in a car accident where you were at fault and there was a fatality or disability as a result, an umbrella policy may help protect your house and other assets from seizure in case you are sued. Umbrella coverage is usually sold in increments of $1 million, and policies may be relatively inexpensive compared to the protection they provide.
8. Leaving no information to loved ones. We recommend compiling a list of all your accounts and trusted advisors’ contact information and keeping it in a secure place where your loved ones can find it in case you suddenly pass away or become incapacitated. Especially with the proliferation of technology, it’s important to make sure your loved ones can access everything from your banking accounts to your social media accounts.
9. Not maximizing 401(k) contributions. Contributions to an employee retirement plan make it possible to defer some of the income you receive—and the taxes you owe for it—to a later date. The limit on employee contributions for 2016 is $18,000 for employees under 50 years old. Some companies will match 401(k) contributions, often for the first 3-6% of salary that employees defer. Contributing at least this amount means taking full advantage of the matching benefit and may be a good amount to start with for those for whom the maximum $18,000 deferral is not practical.
10. Trying to do your taxes by yourself. It may be prudent to consider working with an experienced tax professional. A tax professional should be up-to-date with tax law changes and may assist you in taking advantage of available deductions and tax credits. In addition, they may also be aware of differences between federal and state includable income and deductions. For example, medical expenses outside of premiums must meet a threshold of 10% of adjusted gross income to be considered for a federal income tax deduction. However, for New Jersey state income taxation, the medical expense gross income threshold is 2%, which may be easier to reach for parents of small children who go to the doctor a lot!
These are just a few of the common mistakes we’ve seen, and it is in no means a comprehensive list. We recommend you consult with your trusted advisors (financial planner, estate planning lawyer, and accountant) in coordinating a comprehensive financial plan.
Modera Wealth Management, LLC ("Modera") is an SEC registered investment adviser with offices in Boston; Atlanta; Hernando, FL; and Westwood, NJ. SEC registration does not imply any level of skill or training. Modera may only transact business in those states in which it is registered/notice filed or qualifies for an exemption or exclusion from registration/notice filing requirements. For additional information about Modera, including its registration status, fees and services and/or a copy of our Form ADV disclosure statement, please contact Modera or refer to the Investment Adviser Public Disclosure website (www.adviserinfo.sec.gov). A full description of the firm's business operations and service offerings is contained in our Disclosure Brochure which appears as Part 2A of Form ADV. This article is limited to the dissemination of general information regarding Modera's financial planning and investment advisory services to United States residents residing in states where providing such information is not prohibited by applicable law. Such general information is not suitable for everyone. Accordingly, this email should not be construed by any client, consumer and/or prospective client as a solicitation to effect, or attempt to effect, transactions in securities or as the rendering of personalized investment or financial planning advice. Nothing contained herein should be interpreted as legal, tax or accounting advice, nor should it be construed as personalized financial planning, investment or other advice. You should contact your tax advisor, accountant and/or attorney before making any decisions with tax, accounting or legal implications. Past performance is no guarantee of future results.