Turn Your Temporary Tax Break into Permanent Savings
by Carrie Schwab-Pomerantz, CFP®, President, Charles Schwab Foundation; Senior Vice President, Schwab Community Services, Charles Schwab & Co., Inc.
February 16, 2011

Dear Carrie, 

I understand that I'm going to get a tax break this year. Something to do with the Social Security tax. What does this mean for me?

—A Reader

Dear Reader,

Thanks for asking this question. And great timing, too, because the sooner you focus on the tax break you're getting, the sooner you can come up with a plan for making the most of it.

The tax break you're referring to is a reduction in Social Security taxes for 2011. It was included in the tax bill that President Obama signed this past December and lowers the percentage you pay in Social Security taxes from 6.2 percent of your salary to 4.2 percent (up to a limit of $106,800). That's like getting a 2% raise this year. So if you earn $50,000 a year, you could have an extra $1,000 in your pocket. If you earn up to the limit, you could end up with a savings of up to $2,136. That's no small change.

The tricky part is that the extra money comes in small increments in your monthly paychecks. So a potential $1000 bonus for the year could show up as just about $42 extra each paycheck if you get paid twice a month. It's very easy to simply spend that extra money without paying much attention to it. (Which is kind of what the government wants you to do to help boost the economy.) But with a little planning, you can turn your 2011 tax break into a real boost for your own bottom line.

What to do with that extra money
The first thing to do is to calculate how much more you're actually getting. Don't think of it as just "a few extra dollars" in your paycheck. Focus on the exact amount—it's real money that can be spent wisely. Then prioritize. What's the best way to put that money to work for you? Here are some ideas:

• Pay down a debt—If you're carrying a credit card balance or have unsecured debt such as a car loan, up your payment by the amount of your monthly increase. Think of how great you'll feel—and all the interest you'll be saving.
• Build your emergency fund—You never know when that proverbial raining day will arrive. Use these sunny times to prepare for the unexpected. Put your tax windfall into a safety stash to help make sure you have three to six months set aside "just in case."
• Boost you're college savings account—If you're saving for a child's education, every penny counts. Add this extra money while you can—and watch it grow along with your kids.
• Save for something special—There's nothing wrong with treating yourself. If you've been saving for a special trip, put this money in a dedicated savings account and get where you want to go even faster.
• Put it towards retirement—This could be the wisest move of all. If you add this extra money to your 401(k) or IRA, the potential for compound growth is dramatic. Just think—$1,000 earning 7% a year for 30 years would grow into more than $7,600.

How to make saving it easier
If you really want to be smart about saving this extra money, I suggest making it automatic. Whether you're paying off a debt, adding money to a savings account or contributing to an IRA, set it up so that the amount of your tax break is transferred automatically from your checking into the appropriate account. It's easy to do and usually free. And it's the best way to make sure you won't just fritter this money away.

But don't delay. This reduction in the Social Security tax is only for 2011. Come up with your own plan for making the most of this opportunity—and turn this temporary tax break into some permanent savings. Start today!

Important Disclosures

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The type of securities and investment strategies mentioned may not be suitable for everyone. Each investor needs to review a security transaction and investment strategy for his or her own particular situation. Data contained here is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed.

(0211-0989)