It seems that there’s lots of focus on your ‘Retirement Number’ but recently my family has been thinking hard about estate planning, what happens in the unlikely event that both of us parents should die while our Son is in the age of minority?
The big questions for this surround guardianship. However, this topic can be broken down into personal guardianship, and property guardianship, or in other words, one person to care for and raise our child, and one (perhaps the same if you like) person to manage the assets of the estate to ensure that they last as long as possible.
For the personal guardian, it is often a good idea to speak with several people, and have a list of alternates. The lack of a designated guardian will often force the courts to decide who they feel is best, and the lack of alternates can create this situation also. We’re working on that, so I’d like to share some ideas on the Number.
Questions to ask
What do you want the life of the child to be like, and is that realistic? Money can’t buy love, but if you are going to ask another person to raise your child, it will certainly help with the financial burden. According to a report by the USDA the cost to raise a child is around $250K. However, that includes college, and does not (in my opinion) truly reflect ‘adding a child’ to an existing household.
With that in mind, how does one come to a realistic number for the costs of raising a child? The approach I am taking is to look at present day expenses, thinking about food, clothing, childcare, etc. This number then needs to be forecasted out with inflation, and then brought back to day 1 to create a Present Value.
It’s trickier than a ‘Retirement Number’, because that is often set in stone, you know (or hope) to retire at age X, perhaps 65. However, you don’t know when you are going to die, so each year (or more accurately, day) that you don’t, the duration of expenses is reduced.
The solution I am using for this is to create one big ‘bucket’ of assets, and divert out of this into three streams:
- Living Expenses until 18
- College Fund
- $15,000 per year living expenses, inflating at 3% = $205K invested at 6%
- NY State College $10,000 per year (including books etc) – EG CUNY inflating at 5.5% = just under $40K
- Inheritance Excess
So, if I were investing at a 6% return, I’d need $245K today in order to provide support to college age, though he’d be on his own regarding food and lodging in this scenario, and there would be no inheritance….
Running the numbers
I’d consider the above to be a nice ‘bare bones’ approach to this. The next step in the process is to evaluate present assets, deduct out final costs, and see what the balance is. If there was a shortfall from the $245K then this is where life insurance could kick in.
Life Insurance Ladders
Earlier, I mentioned the Present Value changing each year. IE, the 245K needed today would be less if we both were to die the day he was due to attend college. As such, if we were $150K short of this $245K goal today, we needn’t take out $150K of ’17 year’ term insurance (it tends to sell in blocks of 5, but you get the point). Instead, we could take out perhaps 3 policies. For sake of example:
- $50K 15 year term
- $50K 10 year term
- $50K 5 year term
This means that should we die within 5 years he’d get $150K added to the asset pool, but if it was 6-9 years then it would be 100K, and after 10 years, just $50K. Doing this reduces the cost of life insurance (though in reality, at these levels it’s probably not worth the effort). Bigger families (more kids to support) bigger goals for supporting them may make such laddering a viable opportunity though.
Depending on where we are today, and how well we craft a plan for this, it may be that we fall short, or over shoot on the goal. For this reason it’s important to discuss what happens in such situations.. there are many ways to look at this.
EG. Due to poorer than expected investment returns you are short on cover the ‘bare bones’ plan by $30K. What happens? Is it fair on the personal guardians to have insufficient funds to support the living expenses of your child when said child has a fully funded college account? What if feeding the child prevents them from funding their own children’s education? I think it’s important to be able to consider how you’d address this need.
From an estate planning and tax perspective this throws in complications. If we had elected to fully fund 529 plans, getting that money out again might have tax consequences.
Likewise, if it goes ‘over’, and due to bountiful markets you find an excess of $100K at year 10, should that all be assigned to an inheritance, or should things like present day living expenses be ‘goosed’ a little, or could more be put towards college, so that out of state options were looked at?
I’ll be looking through event scenarios like this in order to decide how best to deal with these situations. I think creating an If>Then>Else flow chart will likely be the best way to figure it all out.