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Money Makeovers

The arrival of a new baby has a shocking way of adjusting your priorities. That sweet cry at 3 a.m. isn't the only thing keeping you awake at night -- it's the sudden weight of new responsibilities (college savings, life insurance, a mortgage) along with baggage from your pre-parenting life (student loans, credit card debt, payments on that cute first car). Reconciling the money follies of your past and the cost of your dreams for your child can be overwhelming. It requires new ways of thinking about spending, saving, and investing. It may even call for an "extreme makeover," of the financial kind. Kevin McKinley, C.F.P., an Eau Claire, Wisconsin, financial planner and author of Make Your Kid a Millionaire, consulted with three couples -- all with new babies -- who shared their finances with BabyTalk.

The Quigleys

Couple:Ryan (28) & Kara (28) Quigley

Kids: daughter Mackenzie (2) and son Owen (8 months)

Hometown: Attleboro, MA

Incomes: He earns $55,000; she's a homemaker

Ryan Quigley knows a thing or two about goals. A minor-league hockey player in his early 20s, Ryan now works as a transportation director at a private school -- where he oversees bus routes and keeps tabs on the after-school routines of 700 students -- to keep his recently expanded family afloat. His wife Kara was in the military until she was injured in an accident on duty; she is now a disabled veteran, receiving $200 a month in disability payments. Kara is a stay-at-home mom, but still needs childcare three days a week while she goes to physical therapy.

Their goals: Since saving for college is not as much of a worry (as a disabled veteran, Kara's children qualify for generous assistance with education expenses), the Quigleys have focused their savings on retirement, salting away $450 a month in a plan sponsored by Ryan's employer, which offers a $150 monthly match. They also scour the real-estate ads regularly, looking for a modest three-bedroom Cape Cod home they could buy on a quarter acre of land.

Their roadblocks: The Quigleys pay $1,300 a month in rent on their two-bedroom apartment, which leaves them living paycheck to paycheck and wondering how they will ever accumulate a down payment for their $225,000 dream house. A big portion of their budget  -- nearly $900 a month  -- goes to payments on a recent-model sedan and minivan.

The expert's advice:

• Begin accumulating six months of living expenses in a liquid money market or checking account in case Ryan loses his job or is unable to work  -- especially important since he is the sole breadwinner.

• Cut back on retirement funding somewhat in order to save for a down payment. The Quigleys should contribute just enough to get the employer match from Ryan's job.

• Reduce the car payments. "They are forking over nearly 20 percent of their gross earnings for car payments, and that doesn't include the cost of insurance," says McKinley. "That's too much money to be spending on a rapidly depreciating asset." Instead, the Quigleys should consider selling the cars and buying older, cheaper models, or keeping one nice car for long trips and getting a "beater" car to use for daily commuting and short jaunts. Another option: Sell the cars, and lease instead. Leasing ties up less money and makes decent, reliable vehicles (with little chance of high repair costs) more financially available.

• Consider buying a duplex. If the Quigleys rented out the other half, they could begin building home equity faster than if they wait until they have enough money to purchase a single-family home, and they'd still have more room than their current two-bedroom affords. • Save on childcare by using a dependent care account (DCA). If Ryan's employer offers this benefit, the Quigleys should take advantage of it. DCAs allow employees to make pre-tax deposits to an account out of which the caregiver is paid. Kara could also offer to provide free childcare for a friend or relative on the days she's not at therapy in exchange for the same benefit.

The Lullas

Couple:Claus Lulla (37) & Tiffany Miller (31)

Kids: son Jordan (6 months)

Hometown: New York, NY

Incomes: He makes $45,000; she earns $5,000

While her baby is busy trying out solid foods, Tiffany Miller is busy finishing up her Ph.D. in clinical psychology so she can begin a hospital internship this fall. Though she only receives $5,000 a year as a student, Tiffany's internship will pay $22,000 a year, and she has the potential to make four times that amount in the future. Claus Lulla brought in about $45,000 over the past year as a freelance makeup artist on movies and commercials. He and Tiffany have a few thousand dollars stashed away in tax-advantaged retirement plans, but no will or life insurance.

Their goals: They dream of ditching their rental apartment in New York City (where rents are exorbitant) for a home in the suburbs and would like to have another child. They're also anxious to start an education fund for Jordan.

Their roadblocks: Though Claus's salary is substantial, as a freelancer, it can fluctuate from year to year without stability. The couple also feels daunted by Tiffany's $45,000 in college debt. By taking the subway and keeping splurges to a minimum, the two have amassed a cash cushion of $15,000 and want to put the whole amount toward Tiffany's debt.

The expert's advice:

• Write wills. Both Claus and Tiffany should visit a lawyer to draw up a will, as well as name potential guardians for Jordan. Since they have a relatively simple situation, they shouldn't expect to spend more than a few hundred dollars. They may even be able to do it themselves by visiting www.nolo.com.

• Buy term life insurance. Take out a $500,000 policy on Claus and a $750,000 one on Tiffany (because of the potential for her earnings to be higher, and more predictable). A 20- or 25-year term would be appropriate. They can talk to an agent, or go online at www.accuquote.com or www.bestquote.com.

• Continue to pay off the student loans at the scheduled rate -- any quicker than that and they will jeopardize their other goals. Claus and Lulla should keep the $15,000 for emergencies, since Claus's income is unpredictable, and put it in a relatively liquid investment such as Series I savings bonds (which currently pay 4.66 percent and will go up in payout if inflation rises; see http://treasurydirect.gov).

• Once Tiffany's paycheck gets bigger, she and Claus can move on to their house, retirement, and college planning goals, in that order. They should save another $15,000 for a down payment on a house, then focus on retirement savings. Hopefully, Tiffany's future job will include an employer-sponsored retirement plan, which they should max out. Claus should open a Roth IRA if he has a few thousand dollars to invest. If he can afford more, he can open a "SIMPLE" plan, which allows self-employed investors to contribute up to $8,000 of their income a year.

• Look into state-sponsored section 529 plans for college savings. These plans allow for tax-free growth of all deposits, and tax-free withdrawals for qualified higher-education expenses. (See www.collegesavings.org.) But Claus and Tiffany shouldn't go overboard on saving for higher education; Jordan can always borrow money to go to college, but no bank will lend you the money you need to retire.

The Tappers

Couple:Bill (31) & Cheryl (30) Tapper

Kids: son Aaron (1)

Hometown: Metuchen, NJ

Incomes: She earns $58,000; he brings in $40,000

Bill, a high school physics teacher, and Cheryl, an art director for a book publisher in Manhattan, had a busy year. The couple paid off their credit card debt (to the tune of $20,000), bought a $260,000 home, and most importantly, welcomed their son Aaron to the world. To avoid paying for private mortgage insurance on their new home (required when the down payment is less than 20 percent), they took out two mortgages -- one for 80 percent of the home's value, and a second for 15 percent of the value. The interest rates are 7 percent and 7.6 percent, respectively.

Their goals: The house needs a new furnace, and the Tappers want to put in central air-conditioning. Cheryl would like to have a second child and negotiate a more flexible work schedule so she can spend more time at home. Bill would like to free up the money to go to graduate school, which would qualify him for a raise in the school district. In the meantime, their concerns about retirement loom large. Bill just began contributing to a 403b retirement plan at work, and Cheryl has put the minimum in her 401k for six years. "We cringe when we look at the [small] balances," Cheryl says.

Their roadblocks: Cheryl admits she's a little footloose with her ATM card, withdrawing cash whenever she needs it. As a result, they have little extra cash at the end of the month. Despite their good salaries, Cheryl has "no idea where all their money goes."

The expert's advice:

• Refinance the mortgage. "The Tappers could shave several hundred dollars off their mortgage payment if they refinance," says McKinley. They should aim for a 30-year loan with a rate of 6 percent, and pay off their mortgage as slowly as possible. If they build up excess cash that they would have otherwise applied to the principal, McKinley recommends that they invest it instead. The reason: Liquid assets are essential in the event of a job loss. (If the Tappers lose their jobs and their money is buried in the mortgage, a bank would be reluctant to allow them to borrow against it.) By investing their discretionary money instead of using it to pay off their mortgage more quickly, the Tappers can actually make money. Plus, McKinley reminds the Tappers to deduct the amount they pay in interest on their mortgage from their taxable income (if they itemize) for even further savings.

• Control spending. The Tappers have already overcome the first hurdle: acknowledging the problem. The next step is to track every single penny they spend on a discretionary basis for a month -- meals, clothes, toiletries, movies, gifts, etc. -- and add them all up. Once they realize where the money's going, they can rein in the outflow. Bill and Cheryl must put themselves on a reasonable allowance and stick to it.

• Avoid ATMs that aren't a part of your bank's system. In some cases, banks will charge up to $1.50 for withdrawals made from out-of-network machines.

• Begin building a liquid account for emergencies. With the money the Tappers scrape up from cutting their "where did it go?" spending, they should try to save $15,000 -- about three months worth of living expenses which can also be used for home improvements or car repairs. After they've done that, they can then look to raise their retirement contributions.

• Save for school (for both father and son!). The Tappers should consider New Jersey's new 529 plan (get info at www.franklintempleton.com. By opening an account for their son, he may qualify for a $1,500 scholarship to a state school. Best of all, if Bill decides to pursue his master's, he can transfer the account to himself and pay no taxes on withdrawals.

Laura Rowley is an author and freelance financial writer based in Maplewood, New Jersey.

Family (Financial) Planning 101

Should you both work?According to financial planner Kevin McKinley, C.F.P., unless the parent in question makes more than $25,000 a year or so, the family is probably better off if he or she stays home and performs the childcare that you would otherwise pay for. "On a purely financial basis, the less money a parent makes, the better sense it makes to stay home," says McKinley. "But parents also need to consider the emotional satisfaction they get from working."

How much life insurance do we need? One rule of thumb: A newborn baby needs to inherit roughly 300 times the family's monthly expenses if something happens to his parents, McKinley notes.

Start saving for college. If tuitions continue to rise at the current rate of 5 percent a year, by the year 2019, a four-year public school will cost roughly $95,000 and a private university will run about $240,000. If you can't save, plan to borrow. A child with a college degree may earn $1 million more over her lifetime than a child without one.

Get a durable power of attorney. It allows your spouse to make financial decisions on your behalf in the event you become incapacitated. Without one, your family would have to go to court and have someone appointed as your guardian -- a time-consuming and expensive proposition. It's easy to change your mind later: Simply tear up the document.

Take advantage of flexible spending accounts. Working parents whose employers offer flexible-spending accounts for daycare or medical costs have a huge tax advantage. For example, the law allows you to set aside up to $5,000 pre-tax dollars to pay for qualified care. So if your child's daycare costs $5,000 a year and you're in the 28 percent tax bracket, your actual cost will be just $3,600.

Put aside money for a stay-at-home parent. A non-working spouse can make a tax-deductible contribution of up to $3,000 dollars a year to an individual retirement account (see www.irs.gov).

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