Starting in July, an estimated 39 million U.S. households will start receiving advance payments of the 2021 child tax credit. While many families may be using this extra cash for everyday expenses, from diapers to utility bills, for others, it may be worth spending this money in ways that improve your financial future, financial experts say.
The child tax credit payments, which were set up and expanded under the American Rescue Plan passed earlier this year, amount to $3,000 per child ages 6 to 17 and $3,600 annually for children under 6. The credit is income-based and starts to phase out for individuals earning more than $75,000 a year or $150,000 for those married filing jointly. Families will receive monthly payments of up to $300 per child from June until December 2021.
So what's the best way to use this money? First things first: If you're currently behind on your bills or you're struggling to put food on the table, no question, your payments should go toward housing, food and supporting your family's immediate needs.
But if your family is caught up on bills and has some wiggle room in the budget, it's worth being strategic with this money, financial advisors say. Here are five smart ways to consider using the upcoming child tax credit.
You may be sick of hearing the phrase "emergency savings," but it's important to have money set aside at all times to cover the unexpected. Experts typically recommend that you put away three to six months worth of living expenses.
Parents who have sufficient income to cover basic expenses "should think about replenishing any emergency savings that may have been spent down because of the pandemic," says Christopher Owens, a Maryland-based certified financial planner with Wealthspire Advisors.
Like with a typical tax refund, there are no real restrictions on how families can use this advance payment. That means parents are able to use the money to improve their overall financial situation by doing things like paying down debt.
This not only can improve your credit but helps you avoid costly interest payments. Matt Elliott, a Minnesota-based CFP and founder of Pulse Financial Planning, recommends using a "debt avalanche" strategy, which minimizes the total amount you end up paying in interest.
"This involves making minimum payments on all your loans and allocating any extra dollars toward your highest interest rate loan. Once your highest interest rate loan is paid off, begin chipping away at the next one," Elliott says.
Other experts agree. "Paying down high-interest debt is absolutely the best thing you can do with these additional funds," says Yulia Petrovsky, a California-based CFP with Modern Financial Planning.
As most parents know, unexpected trips to the doctor's office are common with kids, so it may be worth looking into putting some of the child tax credit toward future medical expenses.
"I suspect one option that is overlooked with the advance child tax credit is making a contribution to a health savings account," says David Wattenbarger, a Tennessee-based CFP and founder of DRW Financial.
This year, families can contribute up to $7,200, and individuals up to $3,600, into HSA accounts, which are generally available to those on high-deductible health plans. You can opt to add funds to your HSA at any time through a direct contribution. These contributions aren't tax-free, but they can be deducted on your tax return.
If you have a health-care flexible spending account, you can typically only add money during open enrollment. FSAs are generally offered as a benefit through your employer and have a $2,750 cap for 2021.
That said, due to legislative changes, the IRS has said that employers can elect to allow workers to make midyear updates to their FSA plans. Check with your manager or HR rep to see if you can increase your payroll deductions.
If you don't need the child tax credit immediately, consider putting that money away for your children to pay for college using a 529 account. "Invest it back into your kids," says Nate Nieri, a California-based CFP and founder of Modern Money Management.
If you don't already have a 529 college savings plan set up, these payments could be a good way to kickstart those savings, Nieri says. These accounts are not subject to income taxes, and when you use the funds to pay for qualified education expenses, the withdrawals are typically tax-free as well.
If you're looking to set up a new account, Vanguard has a 529 plan comparison tool to help find the one that works best for you.
Unlike the stimulus checks sent out earlier in the pandemic, the child tax credit isn't exactly free money. Instead, it's a prepayment on your 2021 taxes, which means if you typically owe money to the IRS when you file, you'll have even more to pay back next tax season.
"People need to keep in mind that these are not stimulus payments — they are an advance on their future tax refund, and they need to plan for that accordingly," says Monica Dwyer, an Ohio-based CFP with Harvest Advisors.
If you are a taxpayer who either usually has to pay at tax time or gets very little back, it may be best to opt out of the advance payment program altogether. The IRS will be rolling out a portal where parents can do that in the coming weeks.
You could also save a portion of your payments to cover what you could potentially owe to the IRS. Or parents could bump up the amount of taxes withheld from their paycheck so that they're paying more in federal income taxes now to offset the amount paid in child tax credits.
"I would hate to see people in a situation where they owe more than expected or those who depend on a big refund not understand that it may not be coming next year," Dwyer says.
Not sure how much you can expect in child tax credits? This calculator can help you estimate.