Financing your retirement may be the last thing on your mind as you prepare for parenthood. Considering all the new expenses that come along with a baby, thinking of your personal financial security in the long-term might not be a current priority, but this does not mean it’s not an important one.

Bill Nickles, a financial planner with years of experience, speaks with Dreaming of Baby about the importance of securing your financial future and offers tips and advice on how to prepare for a comfortable retirement.

Daniela: Good morning, Bill, and welcome to Dreaming of Baby. We’re here to assist our readers in their parenthood journey and look forward to discussing with you the financial aspect to parenthood, specifically the risks involved with having poor personal financial health. Before we leap into this discussion, grateful if you could introduce yourself to our readers.

Bill Nickles: Thank you. I am a fee-only financial planner that works with families helping them plan their financial future. I have been in the industry for 20 years and I have had my own firm since 2008.

The financial risks you should not be taking.

Daniela: Thank you for that overview Bill. Based on your extensive experience in the industry, what would you say was the number one risk parents-to-be and parents encounter when financially planning for their family?

Bill Nickles: The biggest risk for parents is sacrificing their own financial well-being in order to save for future college expenses. It is imperative that you take care of your own financial health like retirement planning before setting designated money aside for college.

Bill Nickles: “It is imperative that you take care of your own financial health like retirement planning before setting designated money aside for college”

Daniela: So what would be the order of priorities for a family in the process of managing their financial future?

Bill Nickles: Every family is unique but roughly speaking the order should be:

1. Pay down revolving debt

2. Establish emergency savings

3. Contribute to retirement accounts such as IRAs and 401ks

4. Save for college in accounts such as 529s.

Daniela: Whilst being aware that every family and their financial status is indeed unique, how can a parent ensure their own financial health whilst also setting money aside for their child’s future, specifically college. Do you have any tips that you can share?

Bill Nickles: A good planner should be able to establish a waterfall approach to savings where once one bucket is full it flows to the next bucket. If one is disciplined at budgeting then the goal would be for money to flow to the college savings. I also remind clients that there are advantages to putting money into 529s but for maximum flexibility, you can put money into an Individual or Joint account and earmark those funds for college. If an unexpected expense comes up, which happens in life, the money is not locked in a 529 account. Vanguard has a really nice college funding calculator on their website that can be used to estimate funding costs.

Retirement Accounts: What is the difference between an IRA and a 401k?

Daniela: Thanks for that; earlier on you spoke of the importance of IRAs and 401ks, it would be great if you could go into the mechanics of these retirement accounts, specifically, the differences between the two?

Bill Nickles: Sure. An IRA (Individual Retirement Account) can be set up by an individual and comes in two flavors: a Regular and Roth. Both allow you to contribute towards retirement ($5,500 annually is the max contribution right now) and the investment grows tax-deferred. However, in most cases, you cannot take the money out until age 59 1/2 without incurring a penalty. The 401k (referring to the legislative code that established it) is offered through an employer and is similar but the maximum contribution is higher ($18,000 annually) and the company will sometimes match with a % of the contribution. To go back to the order of funding example, most should contribute to 401k and then an IRA if they have that opportunity.

Daniela: Great, thanks! How much of a contribution would be normal, would this be a percentage of income? Also, let’s say there is a slowdown in income due to one parent being at home, can you reduce your contributions into these vehicles with minimal loss, etc.?

Bill Nickles: It is set up as a percentage of income and you can make changes to that amount. Most plans that I see now allow you to do this very easily on the website for the plan, and there is no penalty for changing the amount you contribute. Normal contribution depends on budget but one should try to contribute at least the amount that would get them the full company match or they are leaving money on the table.

Daniela: Can you please elaborate on this last part – about contributing at least the amount that would get one the full company match?

Bill Nickles: If the company provides a match, human resources should be able to answer this, it is often structured as 50% on the first 6% of the employee’s contribution for example. In that case, the employee putting in 6% would get them the full company match. I should add the caveat that every plan is different and calculating this can be tricky. The example I gave is just one of many structures that I have seen.

Daniela: Thanks for clarifying. Younger parents, of course, aren’t always familiar with these vehicles which is why we want to ensure they have a clear understanding – can they be cashed out in case of an emergency, are they secured or based on the stock market, how do they play with taxes?

Bill Nickles: Taking money out should be avoided if possible but there are ways to do it because it is the contributors (employee’s) money. As with the IRA, any money taken out before age 59 1/2 could have a penalty associated with that withdrawal. You can invest the money in stocks, bonds and cash using mutual funds or other investment vehicles. As with the IRA, the money grows tax-deferred which is a big benefit.

Bill Nickles: “The key to budgeting is discipline, like most things in life.”

Daniela: You also mentioned that one should go for a 401 first, followed by an IRA. Any reason as to why this should be so?

Bill Nickles: Two reasons. One, it allows you to get the company match if it is available. Two, it reduces the amount of money you report on your tax return. For example, if you make $50,000 but put $5,000 in the 401k your taxable income is lowered to $45,000.

Daniela: Very good to know. Can you lose money if the investments you make through mutual funds go down in value?

Bill Nickles: You can; all investing involves some level of risk. You should have a diversified portfolio and long-term horizon for that money, and that is one of the services a good planner should be able to provide. That risk is real and should be addressed but there is also the risk of not investing and not getting a return on your money.

Daniela: I think one thing you can help us with, especially considering that a lot of our readers are early on in their journey, is a better understanding with regards to the risk of not investing. What would be the negative side of just having a savings account and squirreling money away as opposed to using vehicles like the 401k & IRA?

Bill Nickles: Good question. Right now, you earn 0% from a savings account at the bank so over time as prices rise for goods and services (inflation) you are losing purchasing power. An example may help because this is somewhat confusing. If you had $100 in a savings account and today back to school clothes cost $100 in 5 years those same clothes could cost $115 so your $100 could not buy the same amount of clothes. Now, if you extend that scenario out over 40 or 50 years (until one reaches retirement), you can see the danger of not earning a return on your investment. This is a tough concept but I hope that helps.

Daniela: It does, thank you. Does this mean that the risks of not investing outweigh the risks of a part of the mutual funds not performing well?

Bill Nickles: Yes: if you have a long-term horizon on that money which is 5 years plus, and if you have a diversified portfolio which is reasonable for your risk level. Over time stocks have historically outpaced inflation and that is what you are protecting against.

Daniela: So, for parents to be juggling their soon to be increased responsibilities and expenses, do you have any advice on how to budget so that they can still save money for the future but live a comfortable life in the meantime?

Bill Nickles: The key to budgeting is discipline, like most things in life. There are great tools available that you can use but you have to be aware of what you are spending and save or cut expenses where possible. I should add that the longer you invest the better off you will be so budgeting and investing early in life can have a huge impact on your long-term financial health.

Bill Nickles: “The longer you invest the better off you will be so budgeting and investing early in life can have a huge impact on your long-term financial health.”

Daniela: I would like to thank you for your advice and the information you have provided us today. Before we end this interview is there anything you feel that we may not have covered today and that you would like to share with our readers as parting advice?

Bill Nickles: Try not to be overwhelmed and realize there are a great many tools available in these areas. On my website, I try to write about these topics frequently and one can always contact me if they have a specific question.

Daniela: Thank you Bill, and thank you for your time today!

Bill Nickles: Thank you, it was a privilege.

Click here for more advice from Bill Nickles on securing your financial future.