Payroll Tax Holiday – Your Paycheck Withholding Reduced by 2% in 2011

bonus paycheck womanAmerican workers received a 2% pay raise this month (Jan ’11). My paycheck is direct deposited into my checking account and when I logged into my bank account to see that it had been processed, I noticed a few more dollars than usual. My first thought was that I had been paid for a couple of extra things that I do around the office, but the amount of increase was not correct. So when I got to work the next morning, I took a long look at my pay stub and realized that the amount of Social Security withholding had been reduced!

Then I remembered hearing that a Social Security tax holiday was part of the tax compromise between President Obama and Congress back in December of 2010 as part of the Bush tax cuts extension bill. In 2009, I actually proposed a similar idea of a conservative compromise for economic stimulus during the run up to the American Recovery and Reinvestment Act. Maybe Congress took the idea from me…

The bottom line is that the usual Social Security payroll withholding amount of 6.2% has been temporarily reduced to 4.2% for all of 2011. For all workers making less than $106,800 annually, this will immediately increase take home pay by 2%. Workers who earn more than $106,800 annually will see the same decrease, but the increase in take home pay will be different since Social Security is not withheld from earnings greater than $106,800. The employer’s half of the Social Security contributions will stay the same at 6.2%. Self-employed workers will also see their self-employment payroll taxes decrease from 15.3% (12.4% Social Security and 2.9% Medicare) to 13.3% (10.4% and 2.9%).

If you did not see a decrease in your withholding tax this month, it might be because your accounting department has not quite caught up with the change in legislation. The IRS has given employers until March 31, 2011 to come into compliance with the law and  to correct any over withholding of social security tax. This means that your employer cannot just begin the extra withholding in March, they must “catch you up” so some workers could see a large increase in their paycheck in March if the adjustment was not made in January and February.

For employees making close to the United State’s median income of $50,000 per year, the Social Security withholding tax holiday will put another $1,000 in their pockets. This is great news for most of  us who are feeling the effects of a slow economy. An extra 2% in my paycheck every month should just about cover the increase in gas prices

What will you do with the extra money?

Wait, don’t just go out and spend the extra cash! Make a plan! I recommend that you treat this extra money like windfall profits. For most of us this is unexpected money for which we have not budgeted. Here are three suggestions to make the most of the extra 2% in your paycheck:

1. Pay down debt
Use the extra $40 or $50 or $60 a month as the beginning of your debt snowball. If you have a car loan (especially an upside down car loan), paying an additional $50 a month will help you get a whole lot closer to debt freedom in 2011.

2. Open an IRA
If you are like me, you do not expect Social Security to be solvent in forty years, even if the Social Security eligibility age is increased. Take this chance to use money that might be otherwise being poured down the drain and start to build your nest egg. You may need to consult a financial advisor in order to determine whether or not a Roth IRA or traditional IRA (i.e. know the difference between a traditional and Roth IRA) is best for your situation, but this 2% Social Security tax holiday might be just the thing to get your retirement savings kick started. To make opening a new retirement savings vehicle even more enticing, ING Direct is offering a $50 bonus to anyone who opens an IRA account for a limited time. (later edit: this offer has expired)

3. Give it away
Find a fun way to give the extra money to someone who needs it. Make it a family project to find a need each month and meet that need. It’s always positive to fit giving into your budget, especially if you’re looking to practice good stewardship.

4. Blow it
Okay, this not the usual personal finance blogspeak, but if you have your financial house in order – low or no debt, an adequate emergency fund, contributing to savings regularly, etc. – why not have some fun with the extra money? Go on an extra date with your significant other each month, spend the cash on your hobby or save for a vacation. Money is a tool – do not be so uptight that you cannot have a little fun with it. You might even save a few jobs in the process.

What do you plan to do with the extra cash in your paycheck?

  • Tara

    I don’t know how it affected others but my 2% reduction was completely negated by a rise in federal taxes.

    • Lulu

      Ditto, it was a disappointment.

  • Money Beagle

    My 2% reduction is a fabrication as well. Our health care premiums went up so much in 2011 that, not only did the 2% not cover the extra costs, but I had to increase our exemptions as well to have the paycheck equal out (which is fine, because we get a large federal tax refund). So no extra for me!

  • Lulu

    I want to agree with the people above as my paycheck did not increase either. Some people (teachers specifically) saw a DECREASE in our checks as well because the reduction in Social Security payments made us have more taxable income. We saw varying degrees of reductions in our checks!!!!!!

  • John Thomas

    What affect will this have on taxes for next year? Won’t I need to pay taxes on the extra “x” dollars? Should I adjust my W4 again?

  • not given

    You’re already paying taxes on that 2%, just like you’re paying taxes on the 5.65% they are still taking out for social security and medicare.