So by now, most of you have probably already opened your first paycheck for the year and were unpleasantly surprised by the decreased amount of your take-home pay. In case you were living under a rock for the past few months, here is what caused the tax increase. Well, it is not really an increase. There was a temporary tax break (reducing the Social Security Tax rate from 6.2% to 4.2%) that all American workers got for the last couple of years. This temporary tax break was given to us in an effort to stimulate the economy by letting us have more disposable income and was set to expire at the end of 2012. Congress decided to let the tax break expire and therefore allowing all Americans to effectively lose 2% of their income starting January 2013. There is a lot of speculation on how this payroll tax hike will affect the economy. Many economists predict that the decrease in money Americans have access to on a monthly basis will lead to economic stagnation; some even go as far as predicting another recession. However, regardless of the impact the payroll tax increase will have on the economy, most of us are now mostly concerned with how to immediately deal with the decrease in income and how it will affect our own budget.
The reality is simple – 2% less income is a lot for most of us. If your annual salary is $50,000, then you are looking at bringing home $1,000 less this year. Here are some of my thoughts I would like to share with my prospective and current clients at the Baron Group on how to deal with the payroll tax hike:
1. Reduce expenses. Of course the most obvious response to a reduction in income would be a reduction in expenses. Think carefully about your spending patterns and see if there is any discretionary spending you can easily reduce. Going out to eat, dry cleaning, daily lattes and buying lunch at work are some of the most obvious ones you can cut or reduce.
2. Go generic. If your budget is already reduced to bare necessities, think if you can save money by buying generic brands as opposed to brand names. You don’t have to immediately look at your groceries list. Realistically, most of us prefer a certain brand of food/drink and even if we can easily see that the ingredients are exactly the same, switching to a generic brand doesn’t happen easily. Instead, consider other household items such as paper towels, cleaning supplies, diapers etc.
3. Don’t reduce retirement savings. Reducing how much you contribute towards your retirement goals may seem like a good way to respond to the payroll tax hike. This couldn’t be further from the truth. Remember with savings you have to always consider the effect of compound interest. Specifically, the amount you chose to not save today will be magnified because you will forgo the benefits of continuously accumulating interest on interest. So, before you decide to reduce your retirement savings contributions, explore every other strategy for cutting expenses. Ideally, you will avoid reducing your retirement savings altogether.
4. Increase debt payments. You may think it is counterintuitive to increase payments when your income is reduced. Not when it comes to debt payments. As you are scrubbing your budget to see where you can find a few extra dollars to respond to the payroll tax hike, you may surprise yourself with reductions increasing 2%. If that is the case, and in an event of any room in the budget, I always recommend increasing debt payments. The sooner you are completely debt free, the closer you get to financial freedom and the realization of your financial goals. (Learn how to Eliminate Debt, including your mortgage in a fraction of the regular time)
5. Deserve a higher raise. Usually 2% of annual income is what the average American receives as an annual raise. However, since in 2013 this raise will be eaten by the payroll tax hike, maybe now is the best time to really excel and impress at work so you can make a case for an above average increase this year.
How about you? What will you do (have already done) to respond to the payroll tax hike? Please share in the comments section below.