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Parents with young kids or those expecting a child may wonder: What financial steps should I take to set my family up for success?
There are tax-advantaged ways to save for your child’s future education.
Among the most popular is the 529 plan, which allows parents to invest money for higher education and other costs. The investment grows tax-free, and withdrawals are also tax-free if used for “qualified” expenses.
Qualified costs include enrollment at a college or university, books, computers, and room and board,, among others. They also include up to $10,000 a year of tuition at a private K-12 school, and up to $10,000 on student loan repayments during one’s lifetime.
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One big benefit, Dorsainvil said: Parents can easily change the account beneficiary later if their kid decides not to attend college. That new beneficiary can come from a host of family members. Parents can also withdraw the funds for other purposes, but would owe income tax and a 10% tax penalty on the investment earnings.
While each state has its own 529 plan, parents can invest in a plan outside of their state. Parents might miss out on a state tax break by doing so, but the most important factor when picking a plan is the investment quality, Dorsainvil said.
For example, parents should generally avoid funds with consistent negative returns and with an annual fee (known as an “expense ratio”) exceeding 0.5%, she said.
Parents also shouldn’t save for a child’s education at the expense of their own financial wellbeing, Dorsainvil said.
“There’s no loan for retirement,” she said. “So while it’s super important for our clients to save for our children’s education, we want to make sure they’re putting their financial oxygen mask on first and that they’re saving for their own retirement.”
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Parents who want to invest money for their kids — and not have their funds sitting in cash at the bank — can do so in custodial brokerage accounts.
For example, UGMA and UTMA accounts are held in the name of a minor but controlled by a parent until legal adulthood. That ranges from 18 to 21 years old, depending on the state. (The acronyms stand for Uniform Gifts to Minors Act and Uniform Transfers to Minors Act, respectively.)
One caveat: Once the beneficiary reaches adulthood, the money is theirs. Gifts and transfers made to these accounts can’t be revoked. The beneficiary can then use the money for any purpose.
“I think parents should ask, do they want to relinquish ownership of this money when their child is an adult?” Dorsainvil said. “That is the key question.”
There are other avenues for parents to invest for their kids, but they may be more challenging. For example, parents can set up a Roth individual retirement account for a minor, but the child must have earned income to do so, Dorsainvil said.
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A common misconception is that only the rich need wills and other estate documents — but it’s important for any parent to have a will, Dorsainvil said.
A will is a legal document that shares what you’d like to have done with your belongings and other assets in the event of your death.
Where this especially comes into play for parents with minor children: There’s a guardianship clause in wills that answers the question of who the parent would want to have physical custody of their children should anything happen to them, Dorsainvil said.
If both parents pass away early and there’s no living guardian, the state or court will generally decide — absent a will — what happens to the child, Dorsainvil said.
“I’m pretty sure every parent knows what they want to happen to their kid if they’re no longer there,” she said.
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Dependent care flexible spending accounts are a tax-advantaged way to save for annual costs of childcare.
Dependents and programs must meet various criteria for parents to qualify for the tax break. For example, children must be under age 13; programs like piano or dance lessons, overnight camps and kindergarten tuition are ineligible.
Earmarking funds in a pre-tax account reduces your taxable income, since you don’t pay tax on those contributions.
You can also use the accounts to reimburse yourself for qualified expenses you’re paying out of pocket.