Blog — Sisters for Financial Independence

In a few weeks, many families will start receiving an advance of the Child Tax Credit. This advance can mean having extra cash to help with raising dependents each month for the rest of the year. Alternatively, you can opt-out of receiving the advance payments and wait until you file your taxes next year to receive the full amount. If your income changes in 2021, there could be a possibility that you will have to repay a portion of the advance. You can head to this tool to make adjustments to the payments or other income info. Note: this tool will need to verify your ID so you’ll need to provide some sensitive information to do so.

It’s a good idea to have a plan for this money. If you have the means to and are fairly sure you won’t have major income changes to affect the payment, it may be wise to plan to invest this money for the sake of your child’s future.

In this post, we will review a few options on how you can invest the money you will receive.

What is the Child Tax Credit?

A child tax credit is a tax credit for parents with dependent children. With the passing of The American Rescue Plan, the Child Tax Credit has been expanded for 2021 which means around 92% of American families will now receive some of the payments up to $3,600 per kid between 2021 and 2022.

Here’s the breakdown:

Child Eligibility:

You and your child must be US citizens
Must live with you for at least 6 months out of the year
Have a Social Security number
Claimed as dependent

Age Requirements:

Children aged 5 and under count for $3,600
Kids between 6 and 17 years old count for $3,000
18-year-olds and full-time college students 24 and under can bring parents a one-time $500 payment

Adjusted Gross Income (AGI) Requirements:

Less than or equal to $75,000 as a single filer, $112,500 as a head of household or $150,000 filing jointly, you'll receive the full amount.
Incomes higher than $150,000, your child tax credit payments will begin to phase out by $50 for every $1,000 of income over the threshold.

Save the Money

First option for this money is to spend it for necessities. The goal of this advance is to help families who may have been affected by the pandemic and/or struggling to make ends meet and provide the necessary basics for the family. There’s talk that this change could last five years, but that’s still up for debate.

Research suggests that boosting working families’ income with the credit tend to improve a child’s well-being immediately.

Another option is to top off your family’s emergency fund or save for future expenses for your child: tuition, braces, camps, etc. The possibilities on what you can do with this money can be endless, but the key is to plan ahead. Having a plan for your money is key to financial success.

Invest the Money for Future Education Costs

One option with this money is to invest the money in a 529 Plan. A 529 Account is an account that allows you to save for future educational expenses for your child. Contributions to a 529 Plan are post-tax, but withdrawals are tax-free as long as it’s for qualified education expenses which includes tuition to college, vocation/technical schools and $10K a year towards private elementary, middle or high school tuition.

If you have a child that is 3 years old and you take a portion of the credit, say around $2000 ($166/month) and continually invest it in a plan that provides an average return of 7%, you would have $43,157 by the time your child is 18. That’s a significant amount of money to help pay for school related expenses.

An advantage of a 529 Plan is that it counts as parental assets so it doesn’t have a heavy weighting on the FAFSA (financial aid application).

Invest the Money for Retirement

Another option is to invest the money for retirement: either your retirement or your child’s future retirement.

Fund Your Retirement Account

It might seem weird to use this money for your retirement, but there is technically no limit to what you can do with it. With this in mind, putting funds away for your own retirement can help your children in the long-run. By providing yourself a secure retirement, you can reduce and eliminate the burden of your children having to financially fund your retirement.

If you are 40 years old, have a 10 year old, meet the income requirements, and there are no changes to the amount of the credit you will receive, you could potentially receive 8 years of the child tax credit. Take $2000 (~$166/month) of the credit and invest it in an investment that returns 10% and you would have around $22,872.

Open a Custodial Account

The next alternative is to invest that money for your child instead via a Custodial Account. With a custodial account, you manage the account until your child turns 18 or 21 depending on the age of majority in your state. With this account, you act as the fiduciary and must invest or withdraw with the best interest of the child. If you do this and let the account sit until the current standard retirement age of 65, this account has the potential to grow for them.

If your child is 10, and you invest $2000 ($166/month) for 8 years in an investment that returns 10%, at 18, they would have $22,872, but leave the investment be and draw upon it at 65, that investment will be $2,017,253.

Do this for a child that was born this year (2021), at 18 with 10% rate of return, they will have $91,198 at 18 years old and at 65, they will have $8,043,434.

Just keep in mind with custodial accounts that they count towards the child’s assets and will weigh heavily in the FAFSA. Money into a custodial account immediately become the property of the child and cannot be taken back. In terms of taxation on unearned income like dividends, if the child is under 18, the first $1,050 is untaxed and the next $1,050 is taxed at the child's rate. Anything over $2,100 is taxed at the parent's rate. When the child reaches the age of majority, the account earnings will be subject to the beneficiary's tax bracket at the age of filing.

*10% is not a guaranteed rate of return, but keep in mind you will be looking to invest for a long-period of time - over 40 years in some scenarios.

Open a Custodial ROTH IRA

Another alternative is to open a ROTH IRA on behalf of your children. ROTH IRAs are a tax-advantaged accounts where contributions are already taxed, but the money can grow tax-free and earnings can be withdrawn tax-free at the age of 59.5 or under special conditions. The big thing to note about ROTH IRAs is that it requires earned income so your child would have to be earning income from a part-time job to contribute. This is very possible if you own a business and can hire them. Once they have their own job, they can continue contributing to the account thus increasing their investments.

Open a Brokerage Account, Add them as Beneficiary, Gift Account to them in Estate Plan

The last option is to open a brokerage account under you own name, add them as beneficiary and gift the account to them in your estate plan. The assets will get a “step up” in basis, which will minimize the amount of capital gains tax when it's time to withdraw. All this time, you have control over the account and can use it as you see fit. Then when ready too, you can easily transfer to your child upon death.

Regardless of which option you choose, you could go with one account and open another if and when you fit the requirements, the power of compound interest can play a huge role in securing your child’s future. And $166 a month may also seem large, but you don’t have to start with that amount. Even small amounts add up. It’s the idea of building that consistent habit of saving and investing.

Here are calculators to use to help you understand the potential growth of your investment. Try a conservative rate of return to be on the safe side. Numbers in the above examples have been calculated using rounded monthly contributions and annual compounding. Rounding differences are possible.

Baby Bonds

Currently, in Congress, Senator Cory Booker and Representative Ayanna Pressley have legislation under the American Opportunity Accounts Act to start up a baby bonds program that would give every child in America a savings account seeded with $1,000 when they are born. Children would receive up to $2,000 more each year, depending on their family’s income, and wouldn’t be able to access the funds until they turn 18. The money can then be used to buy a home, pay for school, start a business or save it for retirement. These funds would sit in a federally insured account managed by the Treasury Department, achieving roughly 3 percent interest.

The goal of the Baby Bonds is to close the racial wealth gap and “establish the foundation of a solid financial future for our kids and serve as a down payment on the milestones that too many families find are out of basic reach.”

Overall, the proposal would cost approximately $82 billion annually, or less than 10 percent of the annual expenditure on Social Security.

Essentially with your move to invest the child tax credit, you’d be creating your own baby bond.

If you are unsure about how investing can help you and your family, take a look at our Investing 101 for First Generation Wealth Builders. It’s a course designed for those who want to understand the basics of investing and change the financial dynamics of their family tree.

Do you know if you will be receiving an advance of the Child Tax Credit? What are your plans for that money?