Invest Your Tax Cut in Your Retirement

President Obama's recent deal with Congress kept most income taxes from increasing in 2011 or 2012, and it provided a one-year cut in the employee part of the Social Security tax. That cut gives nearly every working person a tremendous opportunity to jump-start their retirement plan.

Unlike ordinary income taxes that feed the government's general fund, Social Security taxes ostensibly go toward funding that retirement program. So with this tax cut giving you back money that should be going toward your retirement anyway, where better to put cash than toward that very same retirement?

It might be your only chance
After all, Social Security's own trustees already claim that the program's trust fund will completely run out of cash by 2037. Without any major structural changes, when that trust fund is depleted, benefits will be forcibly reduced. While the one-year tax cut won't hasten the trust fund's demise, since the gap will be covered out of the government's general fund, nothing about the program's long-term shortfall is really changing.

The tax cut amounts to 2% of your salary back in your pocket, for up to the first $106,800 of earned income. That can be as much as $2,136, but regardless of the amount you actually get, it's actually the perfect type of money to sock away for your future.

Since it's a one-year temporary tax cut, if you spend that money rather than invest it, you risk seeing it yanked away just as you get used to it. So why not put that cash where it would have gone anyway -- toward your retirement? Every little bit extra can add up, especially if you've got enough time left before you need the money. The chart below shows the amount you'd wind up with for every one-time $100 invested based on the time you have and rate of return you earn:

Any of those results are well within the realm of possibility if the market behaves as it has in the past. Not a bad haul for each $100 of "found money" you'll be receiving.

Where to invest?
If you're not investing enough in your 401(k) plan to maximize your employer's match, that should be your first place to park your newfound cash. By investing there, you add the free money from your employer to the found cash of your tax cut to really turbo-charge your retirement savings at no impact to your current lifestyle. If you already hit your maximum match, consider filling your IRA, then going back and topping off the rest of that 401(k).

If you've already maximizing your qualified retirement plans, it may seem difficult to invest this particular tax cut, given that it'll show up as just a little bit extra in every paycheck. With that in mind, there's one class of investments well-suited to cost-effectively handling small inflows of cash: dividend reinvestment plans (or DRIPs, as they're often called). Those plans offer a low-cost (or sometimes even no-cost) ways to invest small amounts of cash in companies and automatically reinvest the dividends they generate.

The table below shows a handful of companies with DRIPs that offer no-fee enrollments, no-cost investments, and no-cost dividend reinvestment:

Their low fees make them excellent places to consider investing the small boost you'll get with each paycheck as a result of this tax cut. And remember, even though they're not tax-advantaged retirement plans, there's nothing forcing you to spend the money you'll earn in those investments prior to your retirement.

With a one-time, one-year benefit from this tax cut, this opportunity to improve your retirement won't last forever. Take advantage of it while you can in order to shore up your future.