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Parents of young children or those expecting a child may ask: What financial steps should I take to ensure my family’s success?
Here are four of the top considerations, according to Rianka Dorsainvil, certified financial planner and co-CEO of 2050 Wealth Partners. Dorsainvil is also a member of CNBC’s advisory board.
1. Save for your future education costs
There are tax-efficient 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 expenses. The investment grows tax-free and withdrawals are also tax-free if used for “qualifying” expenses.
Eligible costs include college or university enrollment, books, computers, and room and board, among others. They also include up to $10,000 per year in K-12 private school tuition and up to $10,000 in lifetime student loan repayments.
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A big plus, Dorsainvil said: Parents can easily change the account beneficiary later if their child decides not to go to college. This new beneficiary can come from a host of family members. Parents can also withdraw the funds for other purposes, but will have to pay income tax and a 10% penalty tax on investment earnings.
Although each state has its own 529 plan, parents can invest in a plan outside of their state. Parents could miss out on state tax relief as a result, but the most important factor when choosing a plan is the quality of the investment, Dorsainvil said.
For example, parents should generally avoid funds with consistent negative returns and with annual fees, known as the “expense ratio,” exceeding 0.5%, she said.
Nor should parents save for a child’s education at the expense of their own financial well-being, Dorsainvil said.
“There is no retirement loan,” she said. “So while it’s extremely important for our clients to save for our children’s education, we want to make sure they put on their financial oxygen mask first and save for their own retirement.”
2. Invest on behalf of your child
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Parents who wish to invest money for their children – and not leave their cash funds in the bank – can do so in deposit brokerage accounts.
For example, UGMA and UTMA accounts are held in the name of a minor but controlled by a parent until legal adulthood. This ranges from 18 to 21, depending on the state. The acronyms stand for Uniform Gifts to Minors Act and Uniform Transfers to Minors Act.
A caveat: once the beneficiary reaches adulthood, the money is theirs. Donations and transfers made to these accounts cannot be revoked. The recipient can then use the money for any purpose.
“I think parents should ask if they want to relinquish ownership of that money when their child is an adult?” said Dorsainvil. “That’s the key question.”
There are other ways for parents to invest for their children, but they can be more difficult. 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.
3. Update or prepare an estate plan
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A common misconception is that only the wealthy need wills and other inheritance documents — but it’s important for every parent to have a will, Dorsainvil said.
A will is a legal document that states what you would like to do with your property and other assets in the event of your death.
Where it particularly comes into play for parents with minor children: there is a guardianship clause in wills that answers the question of who the parent would want to have physical custody of their children if something happened to them, a declared Dorsainvil.
If both parents die prematurely and there is no living guardian, the state or court will usually decide — in the absence of a will — what happens to the child, Dorsainvil said.
“I’m pretty sure every parent knows what they want to happen to their child if they’re gone,” she said.
4. Use a flexible spending account for dependents
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Flexible spending accounts for dependent care are a tax-efficient way to save for annual child care costs.
Offered in the workplace, RSFs for dependents save families up to $5,000 a year in pre-tax funds for daycare, after-school programs, work-related child care, camps summer day and more.
Dependents and programs must meet various criteria for parents to qualify for tax relief. For example, children must be under the age of 13; programs such as piano or dance lessons, overnight camps, and kindergarten tuition are not eligible.
Allocating funds to a pre-tax account reduces your taxable income, since you do not pay tax on these contributions.
You can also use the accounts to reimburse yourself for eligible expenses that you pay out of pocket.