The $1.9 trillion American Rescue Plan, passed in March 2021, brought a slew of economic relief efforts to help combat the adverse effects of COVID-19.
Along with additional direct payments, an extension of unemployment benefits, growth of the paycheck protection program, among other initiatives, the plan also expanded the child tax credit.
The child tax credit saw a few significant changes for 2021:
- Increased credit amount
- Fully refundable credit
- Advanced payments
How much of the credit does your family qualify for? Are there savvy ways to use the extra payments?
Let’s explore together.
Breaking Down The 2021 Child Tax Credit
How does the child tax credit work?
It’s designed to help people support their families by offsetting their tax liability for every qualifying dependent child.
The American Rescue Plan expanded this integral credit in the following ways:
- It made 17 year-olds eligible for the first time.
- For children under 18, the limit increased from $2,000 in 2020 to $3,000 in 2021.
- For children under 6, the number hops to $3,600.
- The credit is fully refundable, meaning that if the credit reduces the taxpayer’s liability below zero, any leftover funds would be returned.
- The IRS is sending advanced monthly payments, up to $250 for kids under 18 and $300 for kids under 6, starting July through December 2021.
While helpful for all families, the credit primarily supports middle to low-income households, and therefore, comes with phaseout limits for higher earners.
Phaseouts begin for people with a modified adjusted gross income of $150,000 (married filing jointly), $112,500 (head of household), and $75,000 (single). But calculating the phaseouts gets a little tricky. For every $1,000 earned over the income limits, $50 is reduced from the credit.
Let’s look at a quick example.
A young couple with a 2-year-old that makes $170,000 (filing jointly) won’t be eligible for the entire $3,600 enhanced credit. Earning $20,000 over the limit reduces their benefit by $1,000, resulting in a $2,600 credit.
Do you want to see how much your family is eligible for? Use an online calculator to help get a better idea.
Perhaps the most important thing to know about the new child tax credit is that it’s temporary. Currently, the changes are only valid for the 2021 tax year, making it essential to capitalize on the opportunity now.
Tips To Help Your Advanced Monthly Payments Grow
Seeing an extra $250 or so filter into your account each month will likely put a big smile on your face. But how can you put those added dollars to work?
First, Achieve Basic Financial Security
House rule—your basic financial security should come first.
As we at Gen Y like to say, “simple first, sexy later.” Start by using the funds to clean your financial house and get yourself on solid footing before you ‘pass go’ onto other financial strategies.
To do that, concentrate on paying off your credit card debt. Even if your debt is minimal, redirect extra income to eliminate your balance. You’ll be thankful not to have that 16% (or higher) interest rate tailing you month to month.
Once your credit cards are in the black, you can work on building up your emergency savings. While the exact amount will differ for each person or family, most people will do well to shoot for amassing about three months of emergency savings.
Your emergency money protects you against the unexpected—job loss, injury, emergency travel, major repair, etc. When your roof gives out the same month that you’re furloughed, you’ll be happy to have some extra cash to maintain daily expenses like housing, utilities, food, and more.
A healthy emergency fund can provide a cash cushion that protects you from going into debt, whether opening a credit card, taking out a loan, or borrowing from friends and family.
Consider Starting a 529
Once you have a solid financial foundation, you can think about intentionally adding elements to your plan.
It’s never too early to think about investing in your kid’s education, and a 529 Plan can be an excellent vehicle to help achieve that goal. A 529 Plan is a tax-advantaged education investment account. There are two general types: pre-paid tuition plans and education savings plans.
Pre-paid tuition plans allow you to lock in and fund present tuition rates you can use in the future. But the most popular is the education savings plan. With this plan, you contribute after-tax dollars, investment gains grow tax-free, and distributions for qualified education expenses (tuition, room and board, books, supplies, etc.) remain tax-free.
Each state offers its own 529 Plan, and you can open an account in a state you don’t live in, though there may be state tax incentives by opting for an in-state plan. Check here to see if there are state tax benefits available in your state. If there are, it might save you the most money by using the 529 Plan in your state. If not, it’s worth it to explore plans in other states.
With most 529 Plans, investments are limited to a fund menu (similar to a 401(k) plan). Some only offer a handful of managed mutual funds, which can get costly when you consider investment fees. But other programs, like Utah’s My529, bring different investment selections to the table including a handful of low-cost index funds. We like this account because the expense ratios are extremely low on the Vanguard index funds.
529 plans bring structure to your education savings journey. And investing your child tax credit into your child’s education fund is undoubtedly a natural fit.
For example, if you have a 4-year-old child and want to set aside $10,000 per year for 4 years of college, $250 a month could get you to your goal if you earn an average of 6%. You can run your own college savings scenario here.
Leverage Your Roth IRA
Roth IRAs are excellent long-term savings vehicles. While most of the benefits come in retirement, you may be able to withdraw your contributions penalty-free along the way.
You fund a Roth IRA with after-tax dollars, gains grow tax-free, and qualified distributions remain tax-free. Maximizing tax-free withdrawals in retirement is a lucrative benefit that can add freedom and flexibility to your retirement spending plan.
But you don’t have to wait until you’re 59 ½ to withdraw from this account penalty-free. You are permitted to withdraw contributions, not earnings, at any time, without a penalty, though there are some costs, like college expenses, where you can withdraw earnings penalty-free. Even though you can take out contributions (and sometimes earnings) early, it’s often best to keep time—and compounding—on your side and save the funds for retirement.
If you don’t have a Roth IRA, now could be a great time to open one. You can also use your advanced monthly child credit checks to increase your contributions to the maximum ($6,000 per person per year for 2021).
Start a Brokerage Account
If you’re looking for maximum flexibility, opening a brokerage account is a great way to go. You can use a brokerage account to save for a myriad of financial goals: education planning (K-12 and college), dream house, vacation home, new car, etc.
Since the money isn’t housed in a retirement account, you can withdraw it penalty-free at any time. Though you’ll have capital gains taxes to contend with, brokerage accounts are great ways to further your financial goals.
You might want to open a new account for yourself or even one for your kids.
Put Your Money To Work
Money is a tool to help you reach your goals.
Any time you find yourself in the position of having extra money come in, whether, through a tax refund, tax credit, or other sources, it’s essential to use it in productive ways to help further your goals.
The advanced payments for the child tax credit opens up many opportunities for families. You may decide to stash the funds away for a rainy day, or perhaps you’re ready to add to your investment practices. No matter what you choose, make sure you use your resources to find financial security first, then add on from there.
As of July 2021, advanced payments have officially begun! How are you going to use yours to further your family’s goals?