Child Tax Credit and Retirement Investing
Can I Use the Child Tax Credit For a Self Directed IRA?
Many Americans received a pleasant surprise last month with a deposit from the new Child Tax Credit. For some it’s a welcome relief to get some bills out of the way. For others, it can be an opportunity to add to a retirement account. If you’re a participant in a company 401(k), then you may already be maxing out your contribution. However, if you have been thinking about opening a Self Directed IRA, this might the perfect opportunity. Let’s dig a little deeper in the details of the Child Tax Credit and some factors that may influence your spending decisions.
What is the Child Tax Credit?
The Child Tax Credit is a tax benefit of $2,000 per qualifying child. It is partially refundable, which means that if you don’t have enough of a tax bill at the end of the year to use the whole credit, a portion of it will be given back to you in the form of a tax refund. Just for the year 2021, an enhanced version of the Child Tax Credit is being offered as part of the American Rescue Plan Act. The government is sending out advance Child Tax Credits payments over the last 6 months of 2021. These credits are larger ($3,000-$3,600 per child) and these credits are fully refundable. That means families will be receiving full cash payouts for the amount of the credit that is not applied towards taxes. The first installment of these payments was sent out on July 15.
Getting the Child Tax Credit Later
The IRS has started sending out these payments to qualifying families right away. However, taxpayers have the option to forgo the monthly payments and instead collect one lump sum at the time that they pay their taxes. Which is the better option can depend on a variety of factors.
- Income change – If you’re income has changed significantly from previous years, then the government may be calculating your Child Tax Credit wrong and overpaying you. If that’s the case, then when you file for 2021, you might be hit with a tax bill you weren’t expecting. In this kind of situation it may be better just to get the lump sum at the end to avoid any unwanted surprises. You can find out more about unenrolling from the monthly payments on the IRS website.
- Financial planning – Some families do better managing money when it comes in one lump sum. They find it easier to place it where it needs to go in one shot, rather then trying to save it every month. Similarly if the family’s monthly budget is very fine-tuned, it may be better not to disturb that.
- Separated parents – The Child Tax Credit officially goes to the parent who has custody at the moment. The more complicated the custody arrangement, the more complicated the credit dispersal. It’s best to ask an accountant how to handle it, and usually it will end up being easier to divvy up a lump sum.
The Child Tax Credit and a Self Directed IRA
If you want to invest the money, then taking the monthly payment can get you on your way sooner. Contributions to a retirement account like a Self Directed IRA have to come from earned income. That means the Child Tax Credit cannot be invested directly in a Self Directed IRA. However, if you use the Child Tax Credit to pay some of your standard living expenses, then that can free up a portion of your earned income for investing. The "found money” of the 2021 advanced payments can really give people an incentive to start an investment account. Once you successfully get your Self Directed IRA going, it’s easier to set up a contribution schedule to optimize its potential.
If for whatever reason you cannot start a Self Directed IRA (e.g. you are already maxing out your contribution limits with other retirement accounts), there are other investment options available. A 529 college saving plan allows parents to save money for educational purposes with a tax break. You can also invest with a standard brokerage account. It may not receive the same tax benefits as a Self Directed IRA or government sponsored savings account, but it’s still a great way to place your funds productively.
First Steps With a Self Directed IRA
If you are able to use the bump in funds to start a Self Directed IRA, then your next step will be to speak with a Madison specialist. This complimentary call will help you understand the specific financial dynamics of your situation, and determine which kind of Self Directed IRA account is most appropriate for your situation. This is a great opportunity to take advantage of the one-time boost in the Child Tax Credit to help further your financial goals. To schedule a call or contact Madison via email, please visit us here.