No one was more aware of the Social Security payroll tax cut for 2011 than I was. I do the payroll for two (very) small family businesses, so it was part of my job to know about it. I made the changes necessary to do the payrolls correctly, but I never made the leap from thinking like an employer to thinking like an employee.
That’s why I’m glad an article from Vanguard landed in my email inbox.
Giving the Tax Cut a Job
One thing that has worked very well for us is to capture different streams of income – no matter how small – and assign them jobs. For instance:
Well here was a little stream of income – in the form of a tax cut – that I had let get swallowed up by the river of monthly expenses. So now it was time to put it to work.
We considered using our tax savings toward debt – and that wouldn’t have been a bad choice – but decided to use it for retirement savings instead. (Just like the people at Vanguard hoped we would.:-)) Since this tax cut means that we are paying less into Social Security, it made sense to direct it toward retirement savings. Even if Social Security isn’t around when we retire, this is a chance to recapture some of what we’re paying in and direct it toward on our own retirement efforts. And retirement savings come with a tax advantage as well.
How Big a Difference Can a One Year Tax Cut Make?
To get an idea of what this one year tax break could mean down the road, I crunched some numbers. Here’s what I found:
Scenario 1: If you’re someone making $40,000 your 2% Social Security tax cut is worth $800. If you invest that $800 and earn 6% you’ll have $2546 after 20 years or $4594 after 30 years.
Scenario 2: If you’re making $75,000, the amount of your tax cut for 2011 is $1500. Invest it and earn that same 6% and you’ll have $4810 after 20 years or $8615 after 30.
Scenario 3: If you’re earning $106,800 or more, you’re earning the maximum amount subject to Social Security tax, which means your tax break is worth $2136. Invest it at 6% and your investment will be worth $6850 after 20 years or $12,286 after 30.
These are very rough numbers. The 6% return is a random number I chose and the amounts I calculated don’t take into account the return you’ll earn over the year you’re initially investing. They also don’t take into account any tax benefits you may get from investing in a retirement plan.
But the message is clear: You can turn this small tax break now into something much bigger down the road.