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A payroll tax holiday will add money to our pockets in 2011

The biggest Christmas present that many people got this year comes from the federal government. And most will probably fritter it away.

Thanks to the tax bill that President Barack Obama signed recently, a large number of Americans will get a yearlong 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 yearlong tax holiday as well, though they'll still be liable 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 don't contribute to Social Security won't get this temporary break. Still, the payroll tax break is a handout worth about $120 billion, according to the White House. And the administration hopes you will spend every cent to help get the economy going again. In fact, the tax break was shaped 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 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 for you to be anything but deliberate in your effort to put every last dollar to good use. No matter your goal, whether it's to pay off debt or save for a large purchase or retirement, it's probably best to automate your efforts to collect the money.

Best options for tax windfall

WHAT YOU'LL GET: First, estimate your winnings. Kiplinger's put a calculator on its website this week that can help. But keep a couple of things in mind. First, the calculator covers only the 2011 tax cut. Also, it may take a few more weeks before your employer or the company that handles its payroll updates its software to reflect the change. Keep a close eye on your check and how it changes. Remember to take any 2011 salary increase into account.

PAYING DOWN DEBT: If you're paying interest of 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 using some sort of automated payment system to make sure you pay your bills on time. Now that you have a bit more money, adjust your monthly payment higher by the additional amount you're getting from the government. This trick works with mortgage and car payments, as well. Insist the lender applies any extra money to pay down the principal.

SAVING FOR A BIG SPLURGE: If you're determined to reward yourself after a couple of years of hunkering down, have the discipline to salt away the money each pay period until you have enough to pay for the item or vacation in full. Push money from your checking account to a dedicated savings account. Most online savings banks are happy to pull money from your checking account automatically on a regular basis. SmartyPig, however, is custom-made for this save-to-splurge idea. It pays a 1.75 annual percentage yield for balances that are less than $50,000, about the best of any rate offered. And it forces you to be disciplined, because you can't use the service unless you allow it to regularly pull money from your checking account. 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 Airlines gift card. Lands' End, L.L. Bean and Macy's all offer more than 10 percent bonuses. Check the prices for your items first. A 10 percent bonus toward luggage is 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. 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. 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.

A payroll tax holiday will add money to our pockets in 2011 12/27/10 [Last modified: Monday, December 27, 2010 8:58pm]
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