Friday, November 28, 2014

Bouncing Back From the Payroll Tax
April 24, 2014 by Staff Report | No Comments

If you had resolved in January to save more money this year, a recent increase in the Social Security payroll tax to 6.2 percent from…

If you had resolved in January to save more money this year, a recent increase in the Social Security payroll tax to 6.2 percent from 4.2 percent dealt a setback to your plans.

The numbers seem daunting, but there are steps you can take to help make your dollars go further, says Mike Piper, a St. Louisbased certified public accountant and author of Taxes Made Simple: Income Taxes Explained in 100 Pages or Less.

The 6.2 percent rate isn’t a new tax — it’s just a reversion to the old rate. In late 2010, with the economy struggling, Congress agreed to reduce the payroll tax to 4.2 percent from 6.2 percent. The hope was that a little extra cash in consumers’ wallets would help prop up the sagging economy. The short-lived tax break expired at the end of 2012.

The difference is academic: You are taking home less pay, Piper says. Roughly 77 percent of taxpayers have had a larger tax bite taken out of their paychecks due to the 2013 rate, according to the nonpartisan Tax Policy Center. [1]

A taxpayer earning $75,000 a year now sees $1,500 less in take-home pay, or roughly $29 less each week.

According to a recent National Retail Federation survey, a substantial majority of Americans, 58 percent, say they are noticing the squeeze. [2]

Prioritize Your Retirement

So what can you do to plan around this higher tax rate? The first step is to avoid making a short-sighted decision about your retirement savings, Piper says. He explains that even though the increased payroll tax funds Social Security, it won’t directly increase your retirement benefits. As a result, you shouldn’t reduce your retirement contributions in response to the higher tax.

“It simply doesn’t make sense to cut back on your other retirement savings,” he says.

And if you had boosted your retirement contributions when the payroll tax was reduced in early 2011, fight the temptation to reduce your savings rate to previous levels. The more you can sock away in tax-advantaged savings plans such as 401(k)s and IRAs, the more likely you’ll be to reach your long-term financial goals.

Maximize Pretax Dollars

Since you have to maintain your retirement contributions, consider other ways to make your paycheck go further. The federal government offers two — and potentially three — powerful tools to help you do this, and Piper suggests discussing them with your accountant:

The Savers Credit is a tax credit for putting money into retirement plans ranging from work-sponsored 401(k)s to IRAs and SEP accounts. The credit is worth up to $2,000 for joint filers with incomes up to $55,000. Your accountant can help you determine whether you’re eligible for this and other tax breaks.

Another strategy is to direct a portion of your income to a health savings account (HSA) or flexible spending account (FSA). These plans allow you to use pretax money for a wide range of medical expenses, from copayments and prescriptions to eyeglasses and over-the-counter medication.

HSAs are typically reserved for individuals with high-deductible health insurance plans. But if you’re not eligible, check with your employer to see whether your firm offers access to an FSA plan. These plans can help reduce your out-of-pocket health care costs this year, potentially offsetting the higher payroll tax.

A dependent care FSA allows you to set aside pretax income to reimburse yourself for eligible expenses incurred while you work, seek employment or attend school. A married couple or single head of household can contribute up to $5,000 a year, and the limit is $2,500 for a married couple filing separate returns. [3]

Manage Your Spending

Federal tax incentives can make a difference down the line, but you will have to figure out ways to stretch your paycheck every day. Roughly 25 percent of those surveyed by the NRF say they’ll give up small splurges such as music downloads. Had you been eating out more or taking in more movies between 2010 and 2012? If so, consider tightening that area of your budget and finding free forms of entertainment.

While the payroll tax increase could squeeze your family’s finances, Piper notes that the best strategy is simply to adjust other areas of your budget to help offset the lost income.

“Basically, we just have to accept it and move on,” Piper says.

1 Tax Policy Center, “Topping Off the Fiscal Cliff: Whose Taxes Rise and How Much?” 1 Oct. 2012.

2 National Retail Federation, “2013 Tax Returns Survey,” Feb. 2013.

3 Internal Revenue Service, Publication 503, “Child and Dependent Care Expenses.”

This article was written by Wells Fargo Advisors and provided courtesy of Terry R. Campbell and Susan Paolo, Financial Advisors in Chardon at 440-286-2553.

Investments in securities and insurance products are: NOT FDIC-INSURED / NOT BANK-GUARANTEED / MAY LOSE VALUE

Wells Fargo Advisors, LLC, Member SIPC, is a registered broker-dealer and a separate non-bank affiliate of Wells Fargo & Company.

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