By Jonnelle Marte
Now that Congress, after weeks of bickering, has agreed to extend the 2% payroll-tax cut, some advisers are urging their clients not to use those extra dollars on everyday spending.
Lawmakers hashed out a deal that extends the payroll-tax cut, which since January has temporarily reduced the 6.2% payroll tax to 4.2% – for at least two months. The amount of money involved may be so small many don’t notice it in their checks, which is why advisers are urging clients to take note of the boost, and use it to either maximize their retirement savings, pay down debt or budget for a major purchase. “The important thing is to not let that money get lost in your cash flow, because once you do it gets frittered away,” says June Walbert, a financial planner with USAA.
Of course, since the break has been in effect for a year already, the savings may already be taken for granted. but here is a look at strategies advisers recommend for making the most of the 2% tax break.
Pay down debt. Taxpayers may want to calculate how much they’re expected to get back over the year and use that chunk to pay down debt. For example, someone earning $50,000 should expect to save $1,000 over the course of the year (if it the break is extended through the rest of 2012). they may want to pay several car payments at once, knowing they’ll get the money back over the year, says Walbert. Consumers can also use the money to reduce credit card debt, especially on high interest cards, 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. “You’ve got to get rid of that ugly credit card debt,” he says.
Boost retirement savings. while the payroll tax cut can put a little more cash in your pocket, advisers point out that cash will take people further if it’s invested. Those who haven’t maxed out 401(k) contributions may want to increase allocations by about 2%, says Armstrong. Others may consider opening an IRA, in which investors may find lower expenses and more options, adds Armstrong. And in a Roth IRA, the money can grow tax free until retirement and multiply over time. 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. Taxpayers should keep in mind that the extra cash they would get from the payroll-tax cut could be set aside 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.