Here’s a happy fact: For most Americans, paychecks are getting a tad bigger this year.
How much bigger? Starting this month, the typical employee making $50,000 a year will take home an extra $83 a month, or roughly $1,000 a year.
The bump in take-home pay, enacted in late December as part of Congress’ tax-cut extension bill, drops Social Security contributions — for this year only — from 6.2 percent to 4.2 percent on wages up to $106,800.
The so-called “tax holiday” is designed to put a little stimulus in the pockets of recession-weary workers and give the economy another nudge out of the doldrums.
For some, the full amount spread over 26 bi-weekly paychecks will hardly be noticeable. In fact, a handful of people interviewed last week didn’t even know the extra money was coming their way.
Whether most Americans save it or spend it, the extra cash will be welcome.
“It’s not a whole lot of money, so I’ll probably spend it on incidentals: gas, food, things like that,” said data entry contractor Andrew Carroll, 25, who said he’d be getting less than the average U.S. worker’s $996 a year.
Others say they’ll sock the extra away. “I’ll probably act as though I’d never seen it and put it into my savings every month,” said Matthew Parsons, a 35-year-old California Department of Education consultant. “I’m pretty fiscally tight with my finances.”
While it’s tempting to want to spend it freely, financial advisers recommend thinking twice.
“It depends on your individual circumstances. There are many people who need the money to pay bills,” said CPA Greg Burke, a partner with John Waddell & Co. CPAs in Sacramento. “If you have credit card debt, that’s where I’d put it. The interest you’re paying — 20-plus percent — is probably higher than what you’ll pay for borrowing anywhere else.”
Workers don’t have to make any changes to their withholding themselves; the Social Security tax cut is handled automatically by employers and payroll companies. (The amount that employers contribute for their employees’ Social Security doesn’t change: It’s still at the same rate of 6.2 percent.)
Employers must start implementing the lower Social Security tax rate on paychecks no later than Jan. 31, according to the IRS. If any overwithholding of Social Security contributions occurs in January, employers have until March 31 to make adjustments.
Although the paycheck adjustment is handled automatically, the IRS recommends that everyone review their federal withholding once a year. You may need to adjust for certain life changes, such as getting married, having a child, getting divorced, buying a home. If your withholding needs to be changed, submit a new W-4 to your employer.
Dropping the amount that employees contribute this year to Social Security will not harm the fund’s long-term well-being or impact anyone’s future benefits, say federal officials. (The $112 billion shortfall is to be covered by the federal government’s general fund.)
But some financial planners doubt that.
“Nothing’s free,” said Eleanor Blayney, consumer advocate for the national Certified Financial Planner Board of Standards Inc.
In the long run, she and other financial planners believe the one-year cut will contribute to Social Security’s chronic underfunding and likely result in either delaying the age at which you can begin collecting Social Security or lessening the monthly benefit.
For that reason, Blayney urges consumers to plow this year’s extra money into a savings or retirement account to bulk up for the future.
“We all need to be more self-reliant about our retirement. If you haven’t maxed out your 401(k) contribution, use that extra $40 a paycheck. Or consider a Roth or regular IRA.”
Or set up an automatic transfer of that extra 2 percent into a money market, savings or brokerage account.
While the extra may not make “a huge difference paycheck to paycheck, it could make a difference for you on an annual basis,” she said.
Paul Golden, spokesman for the Denver-based National Endowment for Financial Education, suggests some additional ideas for the extra money:
—Avoid a holiday shopping hangover by opening a separate savings fund today for the 2011 holidays.
—Deal with any critical maintenance/repairs to your home or vehicle, such as fixing a leaky roof or buying new tires.
—Build up an emergency fund for unexpected car repairs, medical bills, etc.
“Start with a realistic goal so you get a sense of achievement. Even if it’s as little as $500, it has a psychological benefit,” said Golden.
Once you achieve that goal, work on setting aside the recommended savings for three to six months of living expenses, a cushion in case of job loss or medical surprises.
—And finally, treat yourself. If you’ve got your other savings goals covered, reward yourself — but responsibly, suggests Golden. Use the extra money toward a small vacation or even a flat-screen TV, but not a down payment on a new car that could keep you in debt.
Not everyone gets a break with this new two percentage point payroll tax cut. That’s because last year’s “Making Work Pay” tax credit, which gave working individuals a $400 credit on incomes up to $75,000, expired Dec. 31.
“There’s a crossover point where losing the Making Work Pay credit costs more than getting the 2 percent tax cut,” said Blayney.
Generally, those making below $20,000 a year will take a hit.
Regardless of where you land, Burke reminds that the paycheck bump is only temporary, set to expire at the end of December.
“Don’t depend on it as income. Don’t anticipate it’ll become permanent. It’s one-time savings,” he said. “Treat the money as extra: Either save it, put it away for your kids’ college or pay down your credit card debt.”
Source: McClatchy-Tribune Information Services