Top tips for organising your finances in preparation for parenthood.
How should you prepare your finances for starting a family?
First things first, make sure you know where you stand financially now, and when I say “you” I mean you individually and as a couple. Tot up all income and outgoings and see what you have left over – in other words, calculate your net disposable income.
Review your financial goals in light of your wish to start a family. Will you need a second car, an extra bedroom, or to move house altogether? Work out if these goals can be met – if not immediately, then prioritise into short, medium and long-term objectives.
It is imperative that you have a cash buffer for emergencies. We recommend 3-6 months of living expenses at least. Bear in mind if children arrive on the scene, this sum will need to increase.
If you have savings in excess of this, are they working hard for you? Whilst interest rates on cash deposits are increasing, the value of your cash savings is being eroded by inflation, which currently is approaching 10% - more on that later.
How soon should you start saving and how much?
The sooner the better!
According to the Fidelity Investments 2021 Women and Investing Study 7 in 10 women wished they had started investing their savings earlier and 71% said once they had set up a financial plan, they felt more confident. It is never too late to get started.
Let us start therefore at the beginning - how much it will cost to raise a child in 2022? In a report produced by Liverpool Victoria they quote figures (which exclude housing and council tax) from birth to 18 of:
£160,692 for a couple family
£193,801 for a single parent/guardian
This does not include university tuition fees or private school fees. The largest contributor to the aforementioned figure is childcare followed by food. If you were to factor in university and day school fees the figure would increase significantly.
The Liverpool Victoria report also highlights university fees for home students in the UK have risen to £9,250 per year, with a total average cost excluding accommodation of £22,200 per student to achieve an undergraduate degree (this average is based on the fact the fees are means tested and not all families will pay the full amount).
The best advice is to start saving early. As a rule of thumb every 10 years of waiting, will mean you must invest nearly twice as much to accomplish the same goal, assuming no change to the target end date. Let compounding help you along the way. It may seem overzealous but if you can start provisioning for a child’s higher education as soon as they are born, you are giving your child the best opportunity to achieve it.
From which areas might you be able to divert money for this purpose, e.g. what could you cut back on and or how could you maximise your income to enable this?
While reviewing your finances, you should certainly review your debt position. Your mortgage is likely to be the largest debt you owe. For those on a tracker mortgage or standard variable rate mortgage, see if you can agree a fixed rate before rates rise further.
This also applies to future spending. You may have previously bought a car on HP or PCP for example - check the rates carefully and decide if it might not be more manageable to buy a second-hand car outright. Try to avoid credit card debt, or if you are unable to pay this off right away, try to find a 0% balance transfer deal.
Review your service providers for things like utilities to ensure that you are still on the best available deal. As we are all too aware – energy prices have a big impact on our cost of living.
For cash savings, make sure that they are in an interest-bearing account. With the base rate of interest expected to rise to 4% or more, now is the time to make sure you are making the most of this change in the tides.
On what should you not cut back?
Don’t forget to look after your own future needs. All too often parents are so laser-focused on looking after their children into university years and beyond, that they sometimes forget what they might need themselves. The aim should be not to become a financial burden upon your children later down the line, arguably the most important legacy you can give.
How much is enough? The 50/70 rule suggests that you should aim for an annual income of between 50-70% of pre-retirement income to retain a similar lifestyle. However, you should, of course, consider possible care needs which can be significant. The Government has helped a bit here announcing in January of this year that from October 2023, there will be an £86,000 cap on the amount anyone in England will need to spend on their personal care over their lifetime. Nevertheless, it is important to consider the details of regulation here, as many costs will not count towards the cap of £86,000, and you may end up spending significantly more than this.
In what savings vehicles or types of accounts should you hold the money?
In the current inflationary environment, it is impossible to “save yourself rich”, as a client said to me recently. Cash is still earning low-interest rates, with the bank base rate still only at 2.25% at the time of writing, and we are experiencing high levels of inflation – CPI (consumer price inflation) rose to 9.9% in the 12 months to August 2022. In other words, if you want your savings to grow at least in line with inflation over the medium to long term, you should consider alternatives to cash. You will also need to make sure that your savings are invested as tax efficiently as possible. The Individual Savings Account (ISA) is an obvious savings vehicle in this regard.
The ISA allowance for this tax year is £20,000. ISAs are a straightforward way to invest tax efficiently as they shelter all capital gains and income from tax. The impact of CGT is significant and should not be underestimated, particularly for higher or additional rate taxpayers.
So when you need to start drawing down on these portfolios to pay for childcare or education, for example, there is no tax to pay on any investment gains or income.
Stocks and shares ISAs are flexible and allow you to make withdrawals at any time. With any stocks and shares portfolios, you should tailor the investment mandate according to your timeframe. In other words, when your children are young, you can focus on long-term growth. When you reach the time that you need to start drawing on the portfolio, risk levels can be reduced with a focus on income.
It also makes sense for couples to ensure that they maximise their individual ISA allowances between them before investing in accounts where growth or income could be taxable.
In what should you invest?
Collective Investment Funds are a popular choice for Stocks & Shares ISA Investors.
Managers can invest in a range of assets, each offering differing levels of risk and reward. Common examples include equities, cash and fixed interest securities. Those with a long-term investment horizon, such as a couple setting aside money to fund higher education for their newborn baby, will generally be able to take a higher level of risk.
Which blend of funds and assets you choose should be driven by your personal tolerance for investment risk and capacity for loss. Our recommendation would always be taking professional advice to ensure any proposed investment is suitable for your needs and that it reflects a level of risk that you find acceptable.
If you do not manage to start saving as early as suggested above, are there any ways to maximise/accelerate how you save up for kids?
Some families will be fortunate enough to have grandparents looking for a way to reduce Inheritance Tax (IHT), so they may be willing to help. If they live for seven years or more after making a lump sum gift, the amount will fall out of their estate for IHT purposes. The amount they can gift is unlimited.
Grandparents* can also give away up to £3,000 tax-free each year using their annual gift allowance. To extend the benefits here, Grandparents may consider directing that money into specific investments for children such as Junior ISA or Junior SIPP.
Grandparents can also consider making gifts out of surplus income which will be tax-free, or indeed setting up a trust.
Notes and References:
* Annual gift allowances for IHT purposes are not limited to grandparents.
The contents of this article are for information purposes only and do not constitute advice or a personal recommendation. Investors are advised to seek professional advice before entering into any investment arrangements.
Please also note the value of investments and the income you get from them may fall as well as rise and there is no certainty that you will get back the amount of your original investment. You should also be aware that past performance may not be a reliable guide to future performance.