By Jonnelle Marte
Now that lawmakers voted to extend the payroll tax break to the end of the year, advisers are urging their clients not to let the extra cash in their paychecks go to waste.
Congress ironed out a deal that extends the cut, which since last year temporarily reduced the 6.2% payroll tax to 4.2%. For a taxpayer earning $50,000, that means roughly $1,000 in savings throughout the year, as opposed to a break of less than $200 through February. The amount, when looked at in each individual check may be too small to get noticed, but advisers say the savings add up over the course of the year. Pros are urging clients to take note of the boost and use it to build up their cash reserves, pay down debt and up their retirement savings. “Don’t let this just get lost in your cash flow,” says June Walbert, a financial planner with USAA. “With it really lasting all year long that’s more critical than ever.”
Of course, since the break has been in effect for over a year already, the savings may already be taken for granted. Some may want to start by setting that cash aside to build up a cash reserve of at least $1,000 before using the savings for anything else, says Walbert. But here is a look at other strategies advisers recommend for making the most of the 2% tax break.
Pay down debt. It could pay to crunch the numbers on how much your family is likely to save through the tax break this year and use that chunk of cash to pay down debt, advisers say. Some taxpayers may want to put the money toward their highest interest credit card, says Frank Armstrong, president of Investor Solutions, a registered investment adviser in Miami. For instance, someone getting $80 more a month can increase their monthly credit card payments by that same amount, he says: “Credit card debt is so ugly.” Taxpayers who have some cash on hand and have little or no credit card debt could also knock several car payments at once, knowing they’ll get the money back over the year, says Walbert. Another issue to tackle: student loan debt, says Armstrong.
Boost retirement savings. If you’ve got a good grip on your debt, the next best thing to do with the tax break is to up your retirement savings, advisers say. Those who haven’t captured their employer match on 401(k) contributions may want to increase allocations by about 2%, says Armstrong. “That makes it particularly painless because you don’t see the money and you’re not tempted to spend it on an iPad 3,” says Armstrong. Those already getting the maximum match, may consider opening an IRA, which could offer lower expenses and more options, he adds. And in a Roth IRA, the money can grow tax free until retirement and multiply over time, advisers say. For instance, $1,000 invested in a Roth IRA can grow to $5,000 over a 20-year period with an average 8% total return, says Walbert.
Budget for a big purchase. Some taxpayers may want to set aside the cash to cover upcoming expenses, advisers say. While an extra $40 a paycheck may not feel like a lot, over the course of a year it could be enough to cover a laptop for a child heading to college. Savers could also stash the money each month to use it toward buying a home appliance, says Walbert. But before using the tax break as an incentive to take on more debt, keep in mind that the break is temporary, warns Walbert. “I would proceed with caution counting that into my regular budget because it’s not going to be there forever,” says Walbert.