One of the more important issues for Isabella is Scott’s future education needs. Because of the uncertainty surrounding support from Scott’s biological father, it is important for her to save money over the next eight to ten years to help pay for potential college tuition expenses, or help him get a jump start on life after high school graduation.
Until things are more clear in the budget, and with the short-term goals in mind, it seems unlikely that you can afford to dedicate much in the way of savings here. However, the opportunity to save, if the right habits are built, could be just around the corner. There are a couple of issues to discuss in advance of any money being put away:
- 529 plans vs. other savings vehicles: There are a number of different accounts you could save money in to fund education expenses for Scott. One of the more popular options is the 529 plan. However, this account can only be used for education expenses, and carries penalties that apply if money is withdrawn for any other reason. If you are relatively confident that Scott will attend college, then a 529 plan will be a good option, in addition to other types of accounts. If you are less certain of his educational future, then you may choose to save to a different type of account. These accounts could include a Uniform Transfer to Minors Act (UTMA) account, a custodial Roth Individual Retirement Account (Roth IRA), or an account in your name (with the money earmarked for Scott’s use later). While there are advantages to all of these, keeping the money in your name for now, with the potential to transfer funds to Scott’s name in the future, offers you the most flexibility while you work towards the other goals.
- Who else will help? Does Scott have any grandparents (or other relatives/friends) who may wish to help fund some of his education expenses? Do they want to begin gifting each year in smaller amounts towards that goal? Can you have family/friends gift some of this money at birthdays and other holidays? For example, say Scott’s grandparents spent $100 on birthday presents for him in the past. Could they spend $50 on a present, and put $50 into an account for education? If you can say yes to any of these questions, then it may make sense to open a UTMA account for Scott, and have the money deposited there. A savings account would work as well.
The overall goal is to begin saving for Scott’s education through the new savings habits, once some of the other goals have been funded and your cash flow is more clear.
The landscape for estate planning is very fluid. We should have a better idea of what the long-term estate planning laws will look like in late 2010, but for now there are a few simple documents you should put in place:
- Simple Wills: Each of you should draft a simple will spelling out your wishes at your deaths. This document can be drafted by a lawyer, but there are also some very affordable software programs that can help guide you through the process. A simple internet search can yield results in this area, but having a lawyer draft these documents is always the best way to ensure they are accurate and complete. Neither of you have considerable assets to distribute at this time, but there are other factors to consider:
- Given that you are not currently married, the laws in your state may not recognize you as the proper “heir” to the other’s assets. Specifically leaving property to one another becomes even more important in these instances.
- Much thought and care should be given to the legal guardianship of Scott in the case of Isabella’s death. Isabella’s wishes should be very specifically recorded in her will.
- Durable Power of Attorney: This document will identify the person who will act on your behalf regarding your finances should you be unable to act for yourself. You could each choose to name one another, or choose another person. You can have a lawyer draft this document, or use a standard form which can often be found at your state’s bar association web site or governmental agency web sites.
Living Will: This document will identify medical treatments you wish to receive, or do not wish to receive, if you are unable to act on your own behalf. You can also name a person to make decisions for you should you not be able to make them on your own.
Much of your early investment planning revolves around saving money for an emergency reserve fund, a house, a wedding, and the start of Ethan’s body shop. Given the short-term nature of these goals, an equity (or stock) portfolio isn’t likely the best bet. Money saved for these purposes should be kept in a higher yielding money market fund that provides some safety assurances. Two such funds are:
- ING Direct
- This is a money market fund that is currently yielding about 1.1 percent, depending on your balance.
- This fund is Federal Deposit Insurance Corporation (FDIC) insured, meaning that your money is protected even if ING were to go out of business. This protection is also offered on your bank accounts.
- GE Interest Plus
- This is another money market fund that is currently paying between 1.4 percent and 1.7 percent, depending on your balance.
- This fund is NOT FDIC insured at this time.
- Either of these options will pay you more interest than a basic savings account at your local bank.
Once the short-term goals have been funded, you will look to begin saving for your long-term goals. Because this long-term savings is out in the future, we will not make specific recommendations on the type of allocation desired, but such an allocation will include a mix of equities (stocks) and fixed income (bonds) of varying degrees. You should consult with a financial planning professional to help determine the best allocation choice for you when this saving begins. The financial planning professional will also help you determine the correct types of accounts to save to for your various goals. Such accounts could include 401(k), IRA, Roth IRA and taxable brokerage accounts.
In the near term, Ethan should talk to his employer about the potential to set up a retirement savings plan at work. This can be done through a variety of options, some of which are low cost to administer and would limit the need for funding by the employer themselves. To the degree Ethan is successful at this, you can get assistance from the plan administrator on choosing investment options and contribution amounts.
As important as planning for retirement is, a serious focus in this area can likely take a back seat for the two of you for a while. There are a couple of things that you can focus on, however:
- If/when given the opportunity, save to your 401(k) plan at least to the point of an employer match!
- The savings habits you build for your house and wedding can carry on long past the point of realizing those goals. Once you have funded those items you can continue your monthly savings towards long-term desires, including retirement.
- Once cash begins to build in your emergency reserve account, beyond the desired levels of emergency cash, you can periodically move the excess into a long-term investment account or retirement planning account.
It is the little things in your early years that go a long way towards successful retirement planning. Putting small amounts of money into a Roth IRA each year, and making wise saving vs. consumption decisions, will set you up for the future. Not too far down the road you will be ready and able to take a more serious look at your retirement planning process!
Tax planning is a year-by-year job that often requires the help of a financial professional. You should seek out the assistance of a financial planner or CPA in the area given the large refunds you have been getting on your annual returns. Ultimately, you should match your tax withholdings to the expected liability, and if a refund still exists save that money toward your other financial goals!