The biggest Christmas present that many people will get this year comes from the federal government. And most will probably fritter it away.
Thanks to the tax bill that President Obama signed a week ago, a large number of Americans will get a year-long discount on their payroll taxes in 2011. Normally, employees pay 6.2 percent of their salaries, up to a $106,800 limit, toward Social Security. In 2011, that number will fall to 4.2 percent.
As a result, individuals could end up with a payroll tax savings of up to $2,136 in 2011, according to CCH, a tax information provider. Households with two wage earners who both make more than $106,800 will get $4,272, double the amount for individuals.
The self-employed will share in the year-long tax holiday as well, though they will still be on the hook for the full 6.2 percent of the employer contribution to Social Security. As a result, they’ll pay 10.4 percent in payroll taxes instead of the usual 12.4 percent.
Some government workers and others who do not contribute to Social Security will not get this temporary break. And as Roberton Williams of the Tax Policy Center pointed out in a blog post earlier this month, the payroll tax holiday represents a net loss for many low-income individuals, who will lose access to the Making Work Pay tax credit, which expires at the end of the year.
Still, the payroll tax break is a handout worth about $120 billion, according to the White House. And the administration hopes that you will spend every cent to help get the economy going again. In fact, the tax break was designed with just that in mind. When money dribbles into a paycheck, as this tax break will for many millions of workers, they tend not to save it in the same way that they might if it came in the form of a lump-sum check.
But you should think before you spend. This is too big of a potential win to be anything but deliberate in your attempt to put every last dollar to good use. No matter your goal, whether it is to pay off debt or save for a large purchase or retirement, you’re probably best off if you automate your efforts to collect the money.
Here’s how to do it:
WHAT YOU’LL GET First, estimate your winnings. The personal finance magazine Kiplinger’s put a calculator up on its Web site this week that can help. (I’ve linked to it from the online version of this column.)
Keep a couple of things in mind though. First, the calculator only covers the 2011 tax cut; it doesn’t account for the $400 maximum per person you may lose if you qualified in 2010 for all or part of the Making Work Pay tax credit, which is about to expire. Also, it may take a few more weeks before your employer or the company that handles its payroll has updated its software to reflect the change. Keep a close eye on your check and how it changes, and remember to take any 2011 salary increase into account.
PAYING DOWN DEBT If you’re paying 15 or 20 percent or more on a credit card or other loan balance, it’s probably best to take your gift from the government and apply it to that debt. Hopefully, you’re already using some sort of automated payment system to make sure you pay your bills on time, so as to avoid late fees and interest charges.
Now that you have a bit more money, you can adjust your monthly payment higher by the additional amount you are getting from the government. This trick works with mortgage and car payments as well; just make sure the lender is applying any extra money to paying down the principal.
GIVING MORE AWAY This three or four-figure 2011 bonus isn’t available to people who have no wages. And many of those who are unemployed are placing increased demand on nonprofit organizations that provide housing, food and other services.
Many of these organizations are happy to set up a recurring donation, where they will charge your debit or credit card for whatever portion of your 2011 tax break you want to give them each month. Or, you could push part or all of the additional money to them via a personal check every so often by scheduling a regular payment through the online bill-paying system at your bank.
SAVING FOR A BIG SPLURGE If you’re determined to reward yourself after a couple of years of hunkering down, at least have the discipline to salt away the money each pay period until you have enough to pay in full for whatever it is you have your eye on. You can do this by pushing money from your checking account to a dedicated savings account, and most of the online savings banks are happy to pull money from your checking account automatically on a regular basis.
SmartyPig, however, is custom-made for this sort of save-to-splurge scheme. It pays a 1.75 annual percentage yield for balances under $50,000 right now, which beats any other rate that I’ve been able to find. And it forces you to be disciplined, since you can’t use the service unless you allow it to pull money from your checking account regularly.
Plus, if you put your savings toward spending at its partner merchants, you get a bonus by putting your money on those stores’ gift cards. American Airlines offers a 3 percent bonus, for instance, so $500 of SmartyPig savings would yield a $515 American gift card. Lands’ End, L.L. Bean and Macy’s all offer over 10 percent bonuses.
Just check the prices for your items first. A 10 percent bonus toward luggage does you no good if the bag is available for 20 percent less elsewhere.
RETIREMENT Think you know better than policymakers in Washington? Then take all of this money and put it toward your retirement, even if you need to put it in a regular brokerage account because you’ve maxed out more traditional options like a 401(k) or other tax-privileged retirement account. After all, it was supposed to go toward Social Security in the first place.
If you’re not already maxing out your 401(k) or similar plan contribution at work, raise the amount that your employer takes from your paycheck to match the temporary raise you’re getting because of the payroll tax holiday. This is especially crucial if you’re not taking full advantage of any matching funds that your employer may offer. If you have no workplace retirement plan, the entity that has your individual retirement account or other traditional brokerage accounts should be able to pull money regularly from your bank.
The real beauty here is in the potential for compounding. That luggage bought with the gift card will only depreciate. But $2,000 will turn into $11,487 if it earns 6 percent a year over 30 years.
Your tax dollars at work, right? And you’re going to need them 30 years from now if we keep declaring holidays like this one.
Thanks to the tax bill that President Obama signed a week ago, a large number of Americans will get a year-long discount on their payroll taxes in 2011. Normally, employees pay 6.2 percent of their salaries, up to a $106,800 limit, toward Social Security. In 2011, that number will fall to 4.2 percent.
As a result, individuals could end up with a payroll tax savings of up to $2,136 in 2011, according to CCH, a tax information provider. Households with two wage earners who both make more than $106,800 will get $4,272, double the amount for individuals.
The self-employed will share in the year-long tax holiday as well, though they will still be on the hook for the full 6.2 percent of the employer contribution to Social Security. As a result, they’ll pay 10.4 percent in payroll taxes instead of the usual 12.4 percent.
Some government workers and others who do not contribute to Social Security will not get this temporary break. And as Roberton Williams of the Tax Policy Center pointed out in a blog post earlier this month, the payroll tax holiday represents a net loss for many low-income individuals, who will lose access to the Making Work Pay tax credit, which expires at the end of the year.
Still, the payroll tax break is a handout worth about $120 billion, according to the White House. And the administration hopes that you will spend every cent to help get the economy going again. In fact, the tax break was designed with just that in mind. When money dribbles into a paycheck, as this tax break will for many millions of workers, they tend not to save it in the same way that they might if it came in the form of a lump-sum check.
But you should think before you spend. This is too big of a potential win to be anything but deliberate in your attempt to put every last dollar to good use. No matter your goal, whether it is to pay off debt or save for a large purchase or retirement, you’re probably best off if you automate your efforts to collect the money.
Here’s how to do it:
WHAT YOU’LL GET First, estimate your winnings. The personal finance magazine Kiplinger’s put a calculator up on its Web site this week that can help. (I’ve linked to it from the online version of this column.)
Keep a couple of things in mind though. First, the calculator only covers the 2011 tax cut; it doesn’t account for the $400 maximum per person you may lose if you qualified in 2010 for all or part of the Making Work Pay tax credit, which is about to expire. Also, it may take a few more weeks before your employer or the company that handles its payroll has updated its software to reflect the change. Keep a close eye on your check and how it changes, and remember to take any 2011 salary increase into account.
PAYING DOWN DEBT If you’re paying 15 or 20 percent or more on a credit card or other loan balance, it’s probably best to take your gift from the government and apply it to that debt. Hopefully, you’re already using some sort of automated payment system to make sure you pay your bills on time, so as to avoid late fees and interest charges.
Now that you have a bit more money, you can adjust your monthly payment higher by the additional amount you are getting from the government. This trick works with mortgage and car payments as well; just make sure the lender is applying any extra money to paying down the principal.
GIVING MORE AWAY This three or four-figure 2011 bonus isn’t available to people who have no wages. And many of those who are unemployed are placing increased demand on nonprofit organizations that provide housing, food and other services.
Many of these organizations are happy to set up a recurring donation, where they will charge your debit or credit card for whatever portion of your 2011 tax break you want to give them each month. Or, you could push part or all of the additional money to them via a personal check every so often by scheduling a regular payment through the online bill-paying system at your bank.
SAVING FOR A BIG SPLURGE If you’re determined to reward yourself after a couple of years of hunkering down, at least have the discipline to salt away the money each pay period until you have enough to pay in full for whatever it is you have your eye on. You can do this by pushing money from your checking account to a dedicated savings account, and most of the online savings banks are happy to pull money from your checking account automatically on a regular basis.
SmartyPig, however, is custom-made for this sort of save-to-splurge scheme. It pays a 1.75 annual percentage yield for balances under $50,000 right now, which beats any other rate that I’ve been able to find. And it forces you to be disciplined, since you can’t use the service unless you allow it to pull money from your checking account regularly.
Plus, if you put your savings toward spending at its partner merchants, you get a bonus by putting your money on those stores’ gift cards. American Airlines offers a 3 percent bonus, for instance, so $500 of SmartyPig savings would yield a $515 American gift card. Lands’ End, L.L. Bean and Macy’s all offer over 10 percent bonuses.
Just check the prices for your items first. A 10 percent bonus toward luggage does you no good if the bag is available for 20 percent less elsewhere.
RETIREMENT Think you know better than policymakers in Washington? Then take all of this money and put it toward your retirement, even if you need to put it in a regular brokerage account because you’ve maxed out more traditional options like a 401(k) or other tax-privileged retirement account. After all, it was supposed to go toward Social Security in the first place.
If you’re not already maxing out your 401(k) or similar plan contribution at work, raise the amount that your employer takes from your paycheck to match the temporary raise you’re getting because of the payroll tax holiday. This is especially crucial if you’re not taking full advantage of any matching funds that your employer may offer. If you have no workplace retirement plan, the entity that has your individual retirement account or other traditional brokerage accounts should be able to pull money regularly from your bank.
The real beauty here is in the potential for compounding. That luggage bought with the gift card will only depreciate. But $2,000 will turn into $11,487 if it earns 6 percent a year over 30 years.
Your tax dollars at work, right? And you’re going to need them 30 years from now if we keep declaring holidays like this one.
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