3 Ways to Make the Most of Obama's Proposed Payroll Tax Cut
Oct 13th 2011 11:30AM
Updated Oct 14th 2011 2:40PM
In 2010, Congress cut the Social Security payroll tax that employees pay to 4.2% of wages, from 6.2%. The current proposal would cut those taxes to 3.1% in 2012 for 160 million workers, at a cost of $175 billion. The cut would apply to an individual's first $106,800 in earnings.
So what would the proposal mean for the average American, and what's the best use for the money? The median household income in 2010 was $49,445, according to the Census Bureau. A payroll tax cut from 4.2% to 3.1% would mean an extra $544 a year. That's $41.84 per month, or $10.46 per week. Now before you snub your nose at an extra 10 bucks in your weekly paycheck, consider these wealth-building options for the money:
1. Pay Down High-Interest Debt.
Let's assume you carry the average credit card debt -- about $4,700 in the first quarter -- at the average annual interest rate of 13%. You make a minimum monthly payment of 3% of the balance, or $141. It will take 11 years and nine months to pay off the card and you'll pay about $2,328.17 in interest.
But throw that extra $41.84 a month toward the debt, and voila! You'll be done in 2.5 years and pay just $768 in interest. Try this calculator to figure out your own debt pay down timetable.
2. Sock It Away in a 401(k)
Another way to get real bang for the median wage earner's buck is contributing an extra 1% of your paycheck -- $494 -- to a 401(k) plan. Let's say you work for a company that offers a typical match, such as 50% of contributions up to 6% of pay. You'll get an immediate 50% return on your investment, turning your $494 contribution into $741 a year. Assuming you continue to contribute that amount for 30 years at an average annual return of 5%, you'll have $53,535 to spend in retirement. Use this tool to calculate the potential growth in your nest egg.
3. Open a 529 Savings Account
If you have children you hope will head off to college one day, consider earmarking your potential payroll tax cut for their future. Savings in 529 plans grow free of federal and state taxes, and withdrawals are tax-free if used to pay for qualified education expenses, such as tuition or room and board. Moreover, some states give residents an immediate tax break for their contributions.
Let's assume you have a 3-year-old who will matriculate in 15 years. Jump start your 529 with the $42 from a payroll tax cut and then keep it up monthly until your child enrolls in college. Assuming a 5% annual return, you'll have $11,226 to help with education costs.
Bonus Advice: Not So Thrifty, But More Fun
Finally, if you do decide to splurge, spend the money on unique experiences related to your social life, rather than material things, experts say. We quickly adapt to new stuff and then the thrill is gone. But spending $10.46 to meet a friend for lunch once a week, $84 on a bi-monthly concert tickets for a night out with your partner, or $545 on an annual family camping trip, for example, create memories, joy and well-being that last long after the money is spent.