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What will you do with your tax break?

It's meant to be economic stimulus, but why not use it to bolster your personal finances?

By Karen Datko Jan 5, 2011 1:19PM

This guest post comes from "vh" at Funny about Money.

 

President Obama last month signed a bill that will lower your Social Security taxes from 6.2% to 4.2% for this year only. This tax holiday -- which, bizarrely enough, will cost the federal government $112 billion at a time when it's facing astronomical deficits and we're being told Social Security is headed for hell on a skateboard -- could save you as much as $2,136 this year. If you and your spouse both earn more than $106,800, you'll see a combined $4,272 tax break.

The theory behind it is that the increase people will see in their monthly or biweekly paychecks will be small enough to look like gravy and so they'll diddle it away on stuff and services, thereby supposedly stimulating the economy.

 

Could be. Could be voodoo works to cure warts, too.

 

I must say, if someone handed me $2,136 it would go straight to savings -- even if I were wealthy enough for that amount to apply. O'course, that's not what you're going to see in your paycheck; it'll be dribbled out to you in $178-a-month increments, or $89 per paycheck if you're paid twice monthly. Considerably less, actually, unless you earn a top-tier paycheck. In my case, this vast new lucre will amount, over the entire year, to $288.

 

But let's say you earn enough to matter. In theory, if you're earning that much, you ought to be able to afford to spend two, three, four thousand bucks on anything your heart pleases. The 2-percentage-point tax break applied to my former, relatively modest salary, for example, would have put an extra $1,300 in my pocket -- but in the palmy days when I earned a salary, that was less than I budgeted for the American Express card each month.

 

Several options present themselves:

  • Diddle it away. We're told this will improve the economy, making us all richer and happier sometime in the gilded future.
  • Pay down debt, if you still have any after the past few years of our national frenzy to get out of debt. It would make sense, if this is your choice, to figure out how much the windfall will add to your paycheck and set your online bank account to automatically pay it to the creditor that holds your largest or your highest-interest debt.
  • Set it aside to buy a big-ticket item, thereby keeping yourself out of future debt. A couple thousand bucks would buy you a nice refrigerator or a MacBook. Here, too, the smart strategy would be to arrange an automatic transfer of the temporary raise from checking to savings.
  • Donate it to charity. With the de jure unemployment rate still hovering near 10%, the de facto rate around 20%, and many more Americans poised to be dispossessed of their homes in 2011, the civil thing to do would be to put the money where it can help someone else.
  • Save it for retirement. If this is just a taste of what we can expect, continued raids on Social Security will kill it fast. If you're under 65, you're going to need this money when you find yourself too old to work.

Just now,  my investments are earning between 5% and 7%. Let's say that averages 6% and let's say you're 35 and you earn enough to qualify for the full $2,136 tax break. By the time you're 65, this year's windfall will be worth $12,268. If you and your spouse both earn six-figure salaries, you'll have an extra $24,536 in the community property, assuming you're still married after 30 years. Ah, the miracle of compounding interest!

If it were me, I'd figure charity begins at home. If you have an IRA, this will be an easy way to fund it. Simply have your bank send the extra income straight to the account. Second best: If you're not maxing out your 401k or 403b, have your employer increase your contribution from your paycheck.

 

Otherwise, invest it in a brokerage account, also by automatic deposit.

 

More from Funny about Money and MSN Money:

1Comment
Feb 9, 2011 6:32AM
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I am assuming that if you make LESS than $106,000 a year that the amount you'll be receiving will be considerably less.
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