Tax credit payments aim to ease families’ burden
Starting in July, most families with kids will start getting monthly payments of up to $300 per child as part of the American Rescue Plan’s expansion of the child tax credit.
The payments are scheduled to end in December, and it’s unclear whether they will be extended. But even six months of payments could make a big difference in many families’ finances.
For some, the money will be a lifeline to pay rent, food and other essential expenses. For others, the cash could be a chance to make lasting changes that could help them become more financially stable.
A bigger, better credit
The child tax credit dates back to 1997 and started as a $500 credit designed to provide some tax relief to middle- and upper-middle-income families. Over the years, Congress expanded the size of the credit and made it available to lower-income people, too. In 2017, the maximum credit was raised to $2,000 and income limits were increased to $200,000 for single filers and $400,000 for married couples, after which the credit phases out.
The American Rescue Plan increases the maximum credit, but not for everybody. The new law adds $1,000 for children ages 6 to 17 and $1,600 for children under 6. But the extra amounts begin to phase out for single filers with adjusted gross incomes over $75,000 and married couples at over $150,000. The credit is reduced $50 for every $1,000 of income over those limits.
Taxpayers who are phased out of the extended credit may still qualify for the original $2,000
credit, although again the credit is reduced $50 for each $1,000 of income over the 2017 income limits.
The new law makes two other important changes. The credit is now fully refundable, which means more families can get money back if their credit amount is more than the tax they owe. Also, half of the credit will be paid out in monthly installments from July to December. The other half can be claimed on the taxpayer’s 2021 return, to be filed next year.
The IRS will determine if people are eligible for the monthly payments using their 2020 tax returns or, if those haven’t yet been filed, their 2019 returns, says financial planner Robert Westley, a member of the American Institute of CPAs’ Financial Literacy Commission.
How to use the money
You know best what your family needs, but anyone who doesn’t have an emergency fund should consider one, says Jennifer
Tescher, founder and CEO of the Financial Health Network, a nonprofit that promotes financial stability for lower- and middle-income people. A savings account with just a few hundred dollars is often enough to break the paycheck-to-paycheck cycle.
“Most unexpected expenses that people face are really in the few hundred dollar range,” Tescher says.
Most low- to middle-income families make enough money to cover their expenses, but there’s often a cash flow mismatch between when they need money and when it comes in, Tescher says. That can lead to late fees, bank overdrafts, utility shut-offs and other unpleasant consequences.
“Then, digging yourself out of the mess is time-consuming and expensive,” Tescher says. Drawing from an emergency account and then replenishing it can smooth out those gaps.
Increase your financial health
Once you have a starter emergency fund, you may want to pay down payday loans, credit cards and other expensive debt, Westley says. The less interest you have to pay on debt, the more money you have for uses that you choose.
People also could start or increase their retirement savings, either by contributing to an individual retirement account or boosting their contributions to a workplace plan such as a 401(k). While tax credit money can’t be directly placed into a workplace plan, you can use it to replace contributions that come out of your paycheck.
You may want to save money for a down payment, since homeownership is a common way to build wealth. You also could help your children’s future financial health by saving for their education. Contributing to a 529 college savings plan can provide tax-free money for schooling, and many states offer incentives.
If you don’t already have health insurance, the monthly payments could help you pay the premiums for policies purchased on the Affordable Care Act exchanges at HealthCare.gov. The American Rescue Plan passed in March also increased subsidies, and other improvements have reduced the cost of most policies. Health insurance can help you avoid potentially bankrupting medical bills if someone in your family gets sick or injured.
Having a plan for the money before it arrives can help ensure the cash goes where you most want it, Tescher says.
“Financial Health Network research has consistently shown that planning ahead and identifying specific financial goals is highly correlated with improved financial health regardless of income,” Tescher says.
— This column was provided by the personal finance website NerdWallet. Liz Weston is a columnist at NerdWallet, a certified financial planner and author.