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Retirement Weekly: How to put your child tax credit to work for the future

Around the same time parents are pondering back-to-school plans, many will be receiving their first expanded child tax credit payment. This tax credit represents part of President Biden’s American Rescue Plan signed in March, and is limited to the 2021 tax year.  

Roughly 39 million American families are eligible to receive this credit, which is essentially an advance on half of their 2021 child tax credit, via monthly payments. Those payments range from up to $250 per school-age child age 17 and under, and up to $300 per child under age 6, from July through December 2021. The remaining half will be paid out when parents file their 2021 taxes. 

Keep in mind that the credit is income-based, and starts to phase out for individuals earning more than $75,000 a year, or couples earning more than $150,000 filing jointly. But even some families of means are receiving modest payments — $50 in some cases. 

Because the payments are advances on the credit you would otherwise receive when you file your 2021 taxes, it’s not free money. In fact, some upper-income families may be required to repay some or all of the credit when they file their 2021 taxes. For example, parents with a modified adjusted gross income (AGI) for the 2021 tax year exceeding $80,000 (single filers) or $120,000 (joint filers), must pay back the entire overpayment. That’s why some parents may prefer to opt out of the advance, which you can do on the IRS Child Tax Credit portal at 

But for those who choose to keep the payments, rather than pocket the extra money, why not put those dollars toward the ever-increasing cost of college? 

Why now’s a good time to establish a 529 plan 

The child tax credits are a real bonus for most families, and an opportunity to think about establishing or contributing to an education savings account, like a 529 plan. For most Americans, using the tax credit to start a college savings account or increase your monthly contributions may be a smart financial move. 

By all measures, college comes with a big price tag. Over the past two decades, published college tuition has increased more than any other good or service besides hospital care, with annual college tuition averaging $35,720 in 2021.  

While generous financial aid and scholarships mean that many students don’t pay the full sticker price, the real price of a public four-year degree has more than tripled in 20 years. Saving ahead in a tax advantaged 529 plan can help lessen the sticker shock. 

The benefits of a 529 plan 

Contributions to a 529 are after-tax and not federally tax deductible. And if you invest in your own state’s 529 plan, or if your state is a ‘tax parity state,’ you may benefit from additional state tax benefits. 

Earnings in a 529 plan grow federally tax-deferred, which means your money can compound faster because you don’t pay taxes on investment income or capital gains.  

Withdrawals are tax-free as long as you use the money to pay for qualified education expenses, which typically includes tuition, books, school supplies and room and board.  Qualified higher education expenses also include up to $10,000 in annual expenses for tuition in connection with enrollment or attendance at an elementary school, secondary public, private, or religious school.  

Small contributions or large gifts: It adds up  

While saving your child tax credit for college may feel like a small dent in a big bill, it’s a catalyst to start saving — and to engage your village to help contribute to the college fund. Other friends and family members, including grandparents, can contribute up to $15,000 a year (or $30,000 for couples) without hitting the annual gift tax exclusion.   

You’re also allowed to contribute a lump sum of up to $75,000 to one or more 529 college savings plans in a single year ($150,000 for couples) without being subject to the gift tax. The IRS views the money as an annual gift of $15,000 ($30,000 for couples) over five years. But be careful: if you contribute more money on behalf of the same child during those five years, you may trigger the gift tax. 

Benefit from 529 plan flexibility  

A 529 plan is held in a child’s parents’ name or grandparents’ name with the child as the beneficiary. Thanks to the flexibility of 529 plans, you’re able to transfer the account from one beneficiary to another within your family — or even use it for your own education — without penalty. If you have two children who don’t overlap years in college, you may want to fund one account and change the beneficiary on the account to the younger child once the older student finishes school.  

If you believe your student might be eligible for additional financial aid, it is important to understand how a 529 plan is reported on the standard Free Application for Federal Student Aid (FASFA) application. A 529 plan is considered the parent’s asset, not your child’s. As a result, only 5.64% of the money is generally considered available for college expenses after the Asset Protection Allowance. 

If another family member (like a grandparent) or non-relative owns the 529 plan, the account assets won’t factor into federal financial aid calculations. However, withdrawals in support of a grandchild will factor into the available funding calculations two years after the distribution is made. In other words, distributions made in a grandchild’s freshman year of college could diminish his or her financial aid during junior year. Using those funds in the last two of the grandchild’s college is a helpful strategy. 

Angie O’Leary is head of wealth planning at RBC Wealth Management. RBC Wealth Management does not provide tax or legal advice. We can work with your independent tax/legal advisor to help create a plan tailored to your specific needs. 

RBC Wealth Management, a division of RBC Capital Markets, LLC, Member NYSE/FINRA/SIPC. 

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