For the country as a whole, and many of us, these are trying times. But in 2011, Uncle Sam is throwing us a bone -- in the form of a "Social Security tax holiday."
How it works
If this is news to you, you're not alone. The National Foundation for Credit Counseling discovered that 46% of survey respondents weren't aware of this welcome tax break at all.
You may or may not realize that the "FICA" sums subtracted from your paycheck represent your contribution toward Social Security. The first $106,800 you earn gets a 6.2% haircut, but your employer also kicks in 6.2%, for a total of 12.4%.
In 2011, your employer will still fork over 6.2% of your earnings to the government -- but you'll only pay 4.2%. While a difference of two percentage points might seem small, it's actually kind of a big deal. If your earnings are $50,000, instead of paying $3,100, you'll pay $2,100, saving $1,000!
That sum won't arrive in a single big check, though. Instead, it will simply plump up your paycheck a little bit each pay period. The difference might be easy to miss, but savvy Fools will plan ahead and capitalize on this temporary advantage.
Spend it wisely
Sure, you could let the savings accumulate and splurge on a new large-screen TV. (Uncle Sam hopes you'll do exactly that -- frankly, the economy could use the help.) But other alternatives may leave you with bigger payoffs in the long run.
Remember, 67% of Americans have saved less than $50,000 for retirement. Even a nest egg 10 times that size won't last long in retirement for anyone accustomed to even a reasonably comfortable living. Thankfully, the tax holiday offers you several different strategies to improve your financial standing:
- Pay down your debt. If you're saddled with high-interest credit card debt, you need to pay it off as soon as possible. At an all-too-plausible 20% interest rate, retiring $1,000 in debt will save you $200 in interest alone. In short, eliminating your debt would give you a 20% return on your money -- a result you'll be hard pressed to find anywhere else.
- Bolster your emergency fund. You should set aside somewhere between three and six months' worth of income just in case you lose your job, suffer a medical emergency, or experience some other financial disaster. Avoid volatile havens such as the stock market, where your holdings might suddenly plummet right when you most need them. Instead, consider lower-risk options such as money-market funds or short-term CDs.
- Invest for your retirement. If you sock away $1,000, and if it grows at 8% over the next 25 years, it will become nearly $7,000 -- not bad for a one-year increase in your earnings. Dividend-paying stocks can be a particularly smart move, since they'll keep paying you longafter the 2011 tax holiday becomes a fuzzy memory.
- Fund your IRA or 401(k). If you up your contributions this year with help from the FICA tax break, you'll likely be able to maintain the higher level next year, without even noticing much of a change.
- Do whatever you like. Emergency fund all paid up? No high-interest debt weighing you down? Retirement accounts fully funded? If so, you've got more flexibility. Pay down your mortgage. Start that stock portfolio you've been meaning to get going. Give to your favorite charity. Or, to heck with it, do the economy a favor and get that big-screen TV after all.
Take a little time to assess your financial situation, and determine how best to allocate your short-term windfall. If your finances are precarious, be more aggressive. Augment the tax-holiday savings with additional savings. Relatively small actions today can have a huge impact on your retirement, a decade or more down the road.
There are many money-saving tax tips out there. Get valuable guidance at these sites:
Longtime Fool contributor Selena Maranjian does not own shares of any companies mentioned in this article. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool is Fools writing for Fools.