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Third Time’s the Charm: How the New Stimulus Plan May Impact You and Your Taxes

Another blog about a stimulus plan?  Yes.  While it may seem like a Congressional production of Groundhog Day to those have not suffered financially during the pandemic, we know that several of provisions of the “American Rescue Plan,” which Congress passed earlier this month, offer much needed relief to those who have.  And in either case, this stimulus package, like the two others in the past year, contains a number of changes to the tax law—for 2020 and 2021—so it’s important to note how the stimulus package may impact your taxes or provide other financial benefits. 

Economic Impact Payments.  The IRS has already started sending payments of $1,400 to each qualifying individual and their dependents. Are you expecting a stimulus payment based on having received payments in 2020?  Congress has good news and bad news for you.  The good news:  all dependents claimed on a tax return now qualify for a $1,400 payment, not just children under 17.  The bad news:  income limits are lower for this third round of payments.  Eligibility phases out between $75,000 and $80,000 of adjusted gross income for single taxpayers and between $150,000 and $160,000 for married filing jointly taxpayers, regardless of whether one has dependents.

Similar to last year, the IRS will determine your level of income based on your 2020 tax return.  If you have not filed your 2020 taxes yet, the IRS will use your 2019 return.  If you are eligible for the payment with your 2019 income but not with your 2020 income; it is best to wait for your stimulus payment before filing your 2020 return.

Unemployment Benefits.  The American Rescue Plan prolongs the availability of pandemic unemployment benefits and provides a tax break on 2020 unemployment benefits. 

Child Tax Credit. For families with children up to 17 years old, another bright spot in the American Rescue Plan is the changes to the Child Tax Credit.  In 2020, the Child Tax Credit was $2,000 for each dependent child up to age 16.  For 2021, the credit amount has been increased to $3,600 for children under age 6, and $3,000 for children ages 6 to 17. 

In addition, families may not have to wait until they file their 2021 taxes to receive the benefit.  According to the new law, the IRS will send periodic payments of $250 or $300 (per child) on a monthly basis from July 1 to December 31, 2021, with the remainder being claimed on the parents’ 2021 tax returns.  (However, the IRS has expressed concerns that they may not be able to implement such a wide-reaching program within that timeframe.  Also, if families would rather receive the Child Tax Credit as a lump sum with their 2021 tax return, they can opt out of the monthly payments.)

The increase in the amount and coverage of the Child Tax Credit is only set to apply to the 2021 tax year, but some lawmakers have vowed to try to extend it through subsequent legislation.  Also, note that the additional credit (above the current $2,000 level) will be subject to a more stringent income requirement than the original credit.  If your adjusted gross income exceeds $75,000 for single taxpayers or $150,000 for married filing jointly taxpayers, the additional credit will begin to phase out.  The original $2,000 Child Tax Credit will still be available for families with higher income though.  That portion of the credit will not begin to phase out until income reaches $200,000 for single filers or $400,000 for married filing jointly.

Tax Breaks for Childcare Expenses.  The American Rescue Plan aimed to help families with childcare expenses by sweetening the two main tax breaks on childcare costs—Dependent Care Flexible Spending Accounts (FSAs) and the Child and Dependent Care tax credit.  For Dependent Care FSAs, it raised the limit for pre-tax contributions up to $10,500 in 2021 for most taxpayers (previously $5,000).  For the Child and Dependent Care credit, it increased the maximum level of expenses that can be claimed in 2021 from $3,000 to $8,000 for one qualifying individual and from $6,000 to $16,000 for two or more qualifying individuals.  In addition, the maximum amount of the Child and Dependent Care credit increased to 50% of eligible expenses (previously 35%), though it gradually reduces to 20% for taxpayers with incomes between $125,000 and $400,000.  

Keep in mind, however, that “double dipping” is not allowed.  The Child and Dependent Care credit cannot be claimed for expenses that were paid using a Dependent Care FSA.

Tax Deadline Pushed Back.  Due in large part to the changes contained in the American Rescue Plan, the IRS pushed back the filing deadline for 2020 federal tax returns to May 17th.  Note, however, that state tax deadlines may not change, despite the federal tax extension.

If you have any questions about how these new tax provisions or other aspects of the American Rescue Plan may impact you, please feel free to call or email us, and we will be happy to discuss in more detail.

Clients occasionally raise with us the question of whether to make prepayments against the principal on their mortgage.  Unfortunately, we do not have a one-size-fits-all answer to this question.  Below are some pros and cons and a discussion of factors to consider in determining whether to prepay on your mortgage.

Alternative Use of Funds:  The most significant consideration is to what use you would otherwise put the money.  If, for example, you are considering prepaying a modest amount (e.g., rounding up your mortgage payment to the next hundred) that you would otherwise use on clothes or eating out, then prepaying would allow you to build a bit more equity in your home while decreasing your monthly personal expenses (a double bonus for any financial plan!).  If, however, you are considering prepaying a more substantial monthly amount that you would otherwise save and invest, then you might be better off investing. 

If faced with this enviable problem of extra money at the end of each month, consider first whether you have an adequate emergency fund, whether you are maxing out your retirement plan contributions, whether you need or want to build a taxable investment portfolio, and, if you have young children, whether you are saving for college expenses.  If the answer to any of those questions is “no,” start there.  If you feel comfortable about your savings toward each of those goals, you might still be better off investing extra cash flow in a non-retirement investment account, which would have potentially a better return and certainly more liquidity than prepaying your mortgage.

Interest Rate vs. Expected Returns:  One advantage of prepaying your mortgage is that you will pay less interest on the loan over time.  However, with current interest rates near historic lows, mortgage rates are considerably lower than the expected long-term return from investing in a balanced portfolio.  For example, an investor might expect annual returns of approximately 7 to 8 percent from a 60-40 portfolio (60% in equity, 40% in bonds) over the long term but pay only 3 to 4 percent interest on a 30-year fixed mortgage. 

Also, consider the after-tax value of paying interest on your mortgage.  If you itemize deductions, you at least “get credit” for the mortgage interest that you pay, since you can deduct that amount from your taxable income.  If you take the standard deduction, however, that may make it more appealing to try to pay off your mortgage faster.

Personal Profile:  An individual’s attitude toward debt and stage in life can also be a significant factor in the prepayment decision.  Certain individuals are extremely debt-averse and would be much happier without a mortgage.  Others are approaching retirement and would appreciate the simplicity and security of having their mortgage paid off before ceasing work, especially if they are going to remain in their homes for the foreseeable future and will not receive a pension.   If, however, you are not particularly averse to debt or you are planning to move (and therefore obtain a new mortgage anyway) in the near term, then making prepayments might hold less appeal. 

If you have questions about whether pre-paying the mortgage is right for you, please feel free to call or email any time.

Last week, Virginia529 launched a new investment portfolio, which includes an innovative mix of features from the old Prepaid Tuition program and the current Invest529 program.*  The new portfolio, called the Tuition Track Portfolio, allows investors to purchase “Tuition Track units” that will increase in value each year by the amount of average tuition inflation among Virginia public 4-year colleges.  This could be an attractive method of saving for college expenses, particularly for two groups of investors:  1) those who want their funds to grow but have a low tolerance for investment risk, and 2) those investing for beneficiaries who are a few years away from starting college. 

Key Features of the Tuition Track Portfolio.  Like the other Invest portfolios at Virginia529, contributions to the Tuition Track Portfolio can be:

Unlike the other Invest portfolios, the Tuition Track Portfolio:

Over the past decade, college tuition inflation has averaged almost 5% per year.  Especially in light of the current low interest rate environment, the Tuition Track Portfolio could generate higher returns than many of the other Invest529 portfolios in the coming years, particularly those that are completely (or predominantly) invested in fixed income investments (i.e. cash and bonds).  

An important caveat, however, is that Tuition Track units must be held for three years and the beneficiary must reach college age before the units are credited with “Maturity Value,” which represents the increase in annual average tuition since the units were initially purchased.  Otherwise, as shown in the chart to the right, if investors withdraw the funds from the Portfolio earlier, they will only be credited with their initial contributions (for units held less than three years) or their contributions plus a marginal amount of interest (for units held more than three years but the beneficiary is not yet college age).

Who Should Invest in the Tuition Track Portfolio?  As any parent whose kids started college in 2001 or 2008 could tell you, it is very important to manage the extent to which your college savings are invested in the stock market (and exposed to market volatility) as your kids approach college age.  This means that prudent investors will increase the amount of bonds in their college savings portfolios over time.  However, as mentioned above, average tuition increases may outpace bond returns in this low interest rate environment.  Therefore, investors whose kids are 3 to 5 years from starting college should consider the Tuition Track Portfolio.  The Virginia529 Target Enrollment portfolios for beneficiaries age 13 and older are invested primarily (or entirely) in fixed income.  Considering potential investment returns through that 13-year old’s senior year of college, the Target Enrollment portfolios are unlikely to deliver returns higher than the average annual tuition inflation in recent years.  Plus, the Target Track Maturity Value is guaranteed, unlike investment returns for any of the other Invest529 portfolios. 

Those whose kids are less than 3 years from starting college should only consider buying Tuition Track units if they’re planning to use them for the later years of college, given the holding requirements in the chart above.  Those with younger kids (e.g. under age 13) could consider the Tuition Track Portfolio if they are risk averse and do not want their college savings to be subject to market volatility.  Depending on market performance and the timing of contributions, withdrawals, and changes in investment allocations, there is certainly a chance of obtaining better investment returns with the Tuition Track Portfolio than the Target Enrollment or other Invest529 portfolios, even over a longer timeframe.  Based on long-term averages though, it would be advantageous for parents of younger children to invest in a portfolio with stock market exposure instead.

If you have questions about the Tuition Track Portfolio, investing in 529 accounts, or saving for college in general, please don’t hesitate to call or email our office.  We’re here to help!

*For those unfamiliar with 529 plans, they are tax-advantaged savings plans designed to help pay for education (generally for higher education expenses, but Congress allowed limited use of 529s for K-12 education as well starting in 2018).  The funds in 529 plans can grow and be withdrawn tax-free, provided they are used for qualified education expenses.  Many states also offer state tax benefits for contributing to 529 accounts.

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