5 Smart Ways To Use Your Monthly Child Tax Credit
ICYMI the IRS is rolling out Advance Child Tax Credit Payments starting on July 15th.
Normally, If you have any qualifying children under the age of 18, you would be able to potentially claim the annual Child Tax Credit when you file your taxes.
This year, unless you decide to opt out, the IRS will be paying half of the tax credit in advance monthly payments starting this month. The other half of the credit would still be claimed when you file your taxes next year. This is being done to help alleviate some of the economic woes many Americans are facing.
What Do I Need To Know About the Advance Child Tax Credit Payments?
The amount for the Child Tax Credit in 2021 is $3,600 per child younger than 5 and $3,000 per child ages 6 through 17 at the end of 2021. Previously, the Child Tax Credit was $2,000 per child.
For example, let’s say you have one child that is 3 years old. You may be eligible to receive $1,800 by the end of 2021 in monthly payments ($300 a month from July 15th to December 15th).
H&R Block provides a simple calculator to help you estimate how much of the credit you could be eligible for in 2021: https://www.hrblock.com/child-tax-credit-calculator/
There are several stipulations tied to the Advance Child Tax Credit. You must have EITHER filed a tax return in the last two years where you claimed the Child Tax Credit OR provided info in 2020 to receive the Economic Impact Payments.
IMPORTANT: Since this is an advance payment of the child tax credit, it is an estimate of what your credit amount should be based on your 2021 income.
Therefore, you may want to evaluate the need to opt out of the advance payments. If you think your income may be significantly higher in 2021 or your dependent situation has changed, it may make sense to opt out. If not, you could be in a situation where you owe the IRS when you file your 2021 taxes next year for an over-payment of the Child Tax Credit.
5 Smart Ways To Use Your Monthly Child Tax Credit
With a little extra cash in your pocket, it could certainly be tempting to simply spend the extra money.
To help you optimize the extra boost to your bank account, here are 5 ideas:
1. Start or Increase Your Emergency Fund
First and foremost, if you have not started a fully funded emergency fund (generally 3-6 months of expenses), this could be a great time to start building up your cushion. Your emergency fund should be in the most liquid vehicle possible, such as your bank savings account.
The purpose is to help you avoid tapping your credit cards or going into debt in the case of an unexpected, but inevitable emergency.
Using the payments from the advance child tax credit could help you build up a meaningful emergency fund by the end of the year. You could continue to bolster your emergency fund if needed going into next year.
2. Pay Down High Interest Debt
Focus your efforts on paying down your highest interest debt as aggressively as possible with your excess cash. Credit card debt, payday loans, and other unsecured loans tend to have notoriously high interest rates.
Currently, interest rates are historically low and the earnings in a typical savings account are negligible. However, paying down high interest debt like credit cards or car loans offers you an immediate benefit by saving on interest payments over time and improving your monthly cash flow situation.
If you have federal student loans, this is a great time to throw those child tax credit payments straight back to the government. Because interest rates for federal student loans are currently at zero, any extra payment would be able to go towards principal only, reducing your interest expense over time.
3. Fund a Roth IRA
Consider funding or maxing out a Roth IRA with any excess cash if you’ve already fully funded your emergency fund. You can contribute up to $6,000 in 2021 (up to $7,000 if you are over the age of 50).
Roth IRAs have numerous investment options available. You should be able to position your money for more meaningful returns over the longer term versus just leaving it in cash.
As long as you meet certain conditions, qualified distributions in retirement from a Roth IRA are tax-free, including the earnings growth on the investments. Of course, there are no guarantees when it comes to investing. Any decision you make to fund a Roth IRA and what to invest in should align with your overall goals, risk tolerance and financial plan.
4. Fund a 529 College Savings Account
Open and fund a 529 college savings plan. Saving even a minimal amount on a consistent basis can make a huge difference a decade and a half from now. 529 plans provide a tax-advantaged way to save and invest for higher education expenses for your child or any named beneficiary on the account.
As long as the money stays in the account, investment earnings are not taxed. Additionally, as long as the funds saved in the account are used for qualified education expenses like tuition or other related expenses, withdrawals are generally tax free at the federal level and depending where you live, at the state level as well.
Here in Colorado, you get a state tax deduction for contributions to a 529. Also, the money that comes out is tax free at the state level as long as it’s used for qualified education expenses.
Be aware that you may owe a 10% penalty on earnings if you withdraw the money for anything other than qualified education expenses.
5. Make a Monthly Charitable Contribution
Assuming your emergency fund is fully funded and you don’t have outstanding high interest debt, making a charitable contribution with your excess cash could be an excellent option. With so many organizations strapped for cash coming out of the pandemic, redirecting your dollars for an altruistic purpose can make sense.
If you are eligible for the Advance Child Tax Credit Payments in 2021, take advantage of the extra income coming your way and let it work for you!
Whether that’s contributing to an investment account or paying down debt, you can be intentional with the upcoming cash flow boost over the next six months.
Do not hesitate to contact us with any questions or if you just need some ideas on how to allocate the income.
Schedule a free meeting with me to find out how I can help!
Before you take on any investment or retirement strategy, it is vital that you seek out proper investment and tax advice beforehand. Investment performance is never guaranteed and investments may lose some or all of their value. On top of that, there may be severe tax consequences if withdrawals are taken improperly and can have a significant impact on your portfolio and retirement. Although we provide Investment Advice and Personal Financial Planning Services, we at MWM do not provide tax advice and any tax advice should be rendered by a licensed tax professional such as a CPA.