What to Do With Your Social Security Tax Holiday

The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 provides a one-year tax “holiday” for taxpayers by reducing the amount of Social Security taxes collected.   A tax reduction, you say?  How is that going to work?

The Social Security Tax Rate for employed individuals has been 6.2% on the first $106,800 of income earned.  Any income earned above $106,800 is not taxed by Social Security at all, although taxes are deducted for Medicare on all income earned.  The Social Security Tax “Holiday” reduces the Social Security Tax Rate in 2011 for employed individuals to 4.2% on the first $106,800 of income.  Which means that a person earning $50,000 will save $1,000 in Social Security taxes in 2011, while a person earning the maximum amount of $106,800 will save $2,136.  The employer’s matching contribution of 6.2% has not changed.

But wait! The Illinois Legislature just passed a bill raising state taxes by 2% in 2011, 9.  so the funds that Illinois residents thought they were going to save due to the Social Security “holiday” are now going to be paid to the State instead.

Obviously, the government would like people to spend this money and thereby stimulate the economy.  However, a more prudent choice, should your reduction in Social Security taxes not be totally consumed by the state tax increase, would be to put this money into a retirement fund, either increasing your 401(k) contribution or putting the funds into an IRA.  No one knows what the Social Security Administration is going to do regarding this holiday year when it calculates your benefits, so if you put the money into a retirement plan, at least it has a chance to grow for awhile before you retire, giving you a bigger long term benefit than you will get from buying something now.  If you made a New Year’s resolution to save more, you can use the tax holiday funds to do so.

While the wisdom of this tax holiday is questionable, given that last year Social Security paid out more than it took in, and other commentators agree.

Let’s not look a gift horse in the mouth.  Take whatever you can of your tax cut and do something constructive with it.

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