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Reader Tip: Turn tax savings into true savings

This tip comes from Jamie W., a CPA in Alabama:

Although tax law is not the most exciting thing to blog about, it is one thing that affects every American, every single dollar we earn, and every household budget.

Congress recently enacted legislation that reduces the amount of Social Security tax an employee pays from 6.2% to 4.2%. This change will result in a paycheck increase of 2% for most wage earners in the United States beginning in January of 2011.

For example, if you earn $40,000 per year, you will save $800 in payroll taxes during the year. Although the change is not a huge tax break, it provides an opportunity for many of us to make smart money decisions.

This tax break is unusual in that it is not a lump sum that you receive in the form of a refund at tax time. Instead, your payroll taxes are lowered on each paycheck, thus increasing your take home pay. It could be very easy to spend this money without a purpose. However, you can make this money work for you.

  • Automatically direct 2% of each paycheck into a savings account. These savings could be used to increase your emergency fund or could be saved with a specific purpose in mind.
  • Apply 2% of each paycheck to debt reduction. Multiple small payments through the year will put a dent in your debt by the end of 2011.
  • Budget with a purpose. If there is an area in which you have been struggling financially, direct this 2% of your earnings to that budget line. This will give you breathing room and allow the money to be spent intentionally.

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  • Laurie L. says:

    This is a great post. 🙂

  • Christy says:

    I am a teacher who doesn’t pay SS, therefore I won’t see anymore in my check. Also, Illinois just increased the income tax, so I will be paying $1000 more in income taxes this year. I am making a lot less money for doing the same job. It sure feels like the economy is getting worse, not better.

    • Sarah says:

      I know the feeling, Christy! Pay into STRS instead of SS. Here’s hoping you at least get a pay raise soon!

    • Us too. We work for the state of Ohio and pay into OPERS, not social security. We pay 10% of our gross into OPERS 🙁

    • WilliamB says:

      But how nice for you that for all these years you didn’t have the social security bite taken out of your check!

      • Amanda says:

        I would also like to add you get all the government holidays off and have pensions as a benefit. Plus those that teach, the summers off. I wish I could work for the government. My husband is a sheriff’s deputy so he does not get all the holidays off on the exact day but gets comp days. He also is in the VA retirement system. I have to fund my own 401K. Government jobs are also a lot more stable than non government jobs generally speaking. No matter what job we take, there are pluses and minuses financially. I am quite surprised the government would lower the SS tax as they are already in the hole. Guess my age group will definately never see it. But I guess I will be happy with the additional 2% when I find another full time position.

        • Allison says:

          Not all teachers get all government holidays off, and we don’t get paid for summer months, so of course we get those off. Half the time, we don’t even get the evenings off– It’s 9:00 pm and I’m finally finished with everything I need to have done before first period starts bright and early at 7:20 tomorrow morning, but I still have a book to read that our principal assigned to us and a 12 hour online inservice to complete on my own time sometime in the next month. And my raise this year was $40 per month. Not per day or week, PER MONTH. That can’t even be close to inflation, so I totally understand the discouragement that comes with having to do the same job for less money.

        • rachael says:

          Looking at my pay stub right now, yes I got less taken out in social security but more in federal taxes making it so that the end result is an extra $1 in my pay. Nope not a typo an extra $1 in my check for the two week pay period. That extra $24 this year will sure go a long way, thanks Obama!

        • Andrea says:

          Amanda-I would like to let you know that very few teachers get summers off. Most teachers either work teach summer school or a second job during this time in order to pay bills (I have been in public educations 12 years and have either taught summer school and/or held a second job every summer! One summer I taught summer school for half a day, then worked a second job in addition to going back to grad school full time-3 classes at once!). If they are not working, a lot are going to school and/or staff development. Teachers also have to fund their own 401k. In Texas, teachers pay into TRS (similar to SS-which by the way is about in the same position as SS, already in the hole). Our health insurance skyrocketed this year too only adding to the little we get paid. This is not for me to complain about my job, I love what I do, as most in this field have to in order to continue in it. This is just to let people know that teachers rarely get summers off as most like to put it and that we are extremely devalued in the work force.
          As for teaching being stable, not so in the state of Texas. Public schools in the state of Texas are looking at major budget cuts (ie reduction of teacher staff) again due to lack of funding. In fact, teachers are having a difficult time finding jobs.
          So everyone please just remember, you wouldn’t be where you are today without teachers. Let’s think about that.

          • Rebekah says:

            Wow, I can’t believe someone is jealous of teachers. They work incredibly hard and get paid incredibly little to be incredibly unappreciated. My mom is a teacher and I saw and continue to see firsthand what she has gone through year after year in the broken system..

          • Amy says:

            Nor would you be where you are without the nurse who assisted in your delivery or helped take care of you in your early years! Nurses work 24 hours a day, 365 days a year, and while most of us make a lot of money, we also pay taxes and have downfalls to our jobs.

            We all chose the career we did because we love what we do. That will never change no matter how the taxes vary.

            Crystal thank you for sharing this informative post and helping us to better understand where hard earned money goes.

          • Jennifer says:

            I completely agree. I am in Texas and my paycheck ended up being $24 less because of the tax bracket shift with the federal income tax. It stinks!

  • Tabatha says:

    What a great post!! People don’t generally think about a small pay raise in their check. I feel this same concept could work also if you got a raise at work. If you have been living with a certain income level, why increase spending just because you got a raise? Its so easy to just spend, spend, spend instead of saving but nowadays you almost have to save every penny you can! Thanks!

  • Becky says:

    For those of us living in Illinois, don’t make any plans for the extra 2%. Our state government just raised the Illinois income tax to 5% from 3%, retroactive to 1/1/11, which means your paycheck will have no increase. The 2% reduction in our social security tax will be eaten up by the 2% increase in our state withholding tax. Thank you to our state of Illinois representatives, senators, and governor. 🙁

  • SHAVON says:

    Although….the $400 making work pay credit which had been granted the past two years was not carried into 2011 and several people will see an increase in your federal withholding compared to your checks in december…. (the credit was given to you in a reduction of federal withholding each with and then made up with a $400 credit on your tax return….) ….

  • Erin says:

    We’ve set up 2% of my husband’s paycheck to go in savings. Unfortunately, I don’t pay into SS and my federal witholdings have gone up, so I’m not feeling very stimulated by this years stimulus package! Oh well, at least my husband benefits 🙂

  • Amy Lauren says:

    I noticed this on my last check! I feel like I deserve it because at my job, I work with financial non-profit accounting software, so we had to wait forever on the government to pass this so that we could update our software accordingly :). So I’m looking at it as my little bonus!

  • Amy Lauren says:

    I work on financial non-profit accounting software at work, and while we had to wait forever for them to pass this at the end of the year, at least it’s a little extra money! I’m looking at this small increase as my raise for dealing with so many tax changes in our software at the end of the year!

  • Rhoda says:

    This is so true. For the last five years we have done the same thing with my husband’s raise increase. We put it into a seperate account to put on paying our house off. We also put all of our tax refund towards our house. It really makes a difference.

  • Den says:

    While I appreciate the idea behind this post (save these increases instead of letting lifestyle inflation kick in), the idea does assume that everything else will stay the same….instead we have rising food prices, expected rising gas prices and for us – a huge jump in our payroll deduction for our health care…so like many others this 2% increase is washed out by other factors.

  • Michelle says:

    We received an e-mail from my husband’s benefits department about this change. It effects anyone making less than $103,000 a year and paying into ss. However, the federal making pay work tax credit has been eliminated this year, so for most taxpayers this will even things out. Check out the article on the IRS website. For the majority of people, you will not see a change in your take home pay. In fact, if you live in a state that has state income tax ( I do not), many states have raised their tax as well, meaning your take home will probably be less that last year.

  • Awesome Post! I had no idea this was happening. Thank you so much for sharing! After learning the my husband’s salary will remain the same this year, no yearly raise. I was a little worried because power, water, and health insurance are increasing. I still wanted to have a nice cushion so this news comes at a perfect time.

    • Our electric company has been raising rates every quarter for the last 4 1/2 years! And, they are still doing it! I have worked hard to lower my bill, because the first summer in this house, one month’s electric bill was $520–and we kept our thermostat at 78º. I live in the land of neccessary a/c for 6 or more months of the year because it’s 116º or more. (We had a broken a/c unit one summer and it was 102º in the house for over a month until we got it fixed). If your utilities are rising, look for all the ways you can cut your usage. 1 degree is 2% of your electric bill in summer according to our powder company. I changed the thermostat to 79º, turned off overhead fans when we weren’t in the rooms ($100 a month lower), turned off the computer at night instead of just leaving it sleep ($50 a month lower), turned off all the lights in the kitchen (other lights in the house were already off) except for the ones over the table, and lowered the bill another $20 a month.

      Eventually the rising rates will catch up to us more, but lowering our bill while having major rate increases all the time has been amazing. I didn’t think it was possible.

      Thought your husband didn’t get a raise, there are many who are taking cuts just to stay employed. I know many who are working the same hours or more with 70% cuts in pay.

  • Elizabeth says:

    Good point, Allison! 🙂

  • WilliamB says:

    My employeer sent us a email notifying us of the change, then suggested that we could – if we wanted to – use it to increase our 401(k) contributions or at least enough to maximize the employeer contribution.

    It was one of the best emails I’ve seen from HR.

  • bb says:

    Too bad our health insurance went up 30%….. 🙁

  • Kaycee says:

    Unfortunately, federal withholding went up. So my anticipated/expected pay “raise” of $20+ per paycheck wound up being less than $10. :-/

  • Dona says:

    Well, we were looking forward to this..but we soon discovered that the savings was swallowed up by our health insurance cost rising by nearly 25 bucks a paycheck…so there went that money 🙁

  • Michelle says:

    What a great article!! My husband is a teacher and he loves what he does. Yes there are parents that complain, states that don’t fund enough, administration that is more concerned with not upsetting parents instead of what’s best for kids….but he loves it. He teaches because he loves the kids. Yes the pay isn’t great, but it’s good. He takes home papers to grade nightly, he has tons of meetings he’s not compensated for, he get summers, weekends and random days off here and there… all balances out. In the end, he loves what he does and we are happy.

  • christine says:

    Sadly we got the SS reduced however there was an increase on the federal taxes. So I take home even less money then I did last year. To top it off the state of IL increased their amount as well.

  • Jaci says:

    We noticed this on our first paycheck of the year, however, we also noticed an immense increase in our health insurance premiums. Basically, we are ahead about $5 per paycheck ($130 per year). So although it’s a nice perk, there are ‘reasons’ they are changing the SS tax. That being said, we are amazingly blessed with incredible health insurance and we realize that many are not as fortunate.

  • laura :) says:

    We live in Indiana and were pleasantly surprised to have a total of nearly $100 extra (between my husband and myself) due to the social security tax changing. We’ve had two paychecks this year and have an extra $200. I KNEW if that money stayed in our account, it’d be spent immediately so I went to the bank and opened a separate savings account which is linked to online banking. The first thing I do is transfer our “extra” pay into that account so it’s never missed. This is a first BIG STEP for me. LOL. I’m loving it too!

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