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Offsetting the Payroll Tax Increase with Retirement Contributions

Written by Jeff Rose on March 19, 2013 in Retirement  |   No comments

In 2013, the payroll tax holiday that lowered workers’ taxes by 2 percent came to an end. This effectively raised each individual’s payroll tax from 4.2 percent to 6.2 percent. That might not sound like a lot, but employees have already found that the change…

payroll tax retirement contributionsIn 2013, the payroll tax holiday that lowered workers’ taxes by 2 percent came to an end. This effectively raised each individual’s payroll tax from 4.2 percent to 6.2 percent. That might not sound like a lot, but employees have already found that the change takes a big chunk out of their paychecks.

How much has the tax increase affected individuals?

When the payroll tax holiday expired, it affected workers in a variety of ways. A person earning $50,000 annually will now pay about $3,100 in payroll taxes, where last year she only paid $2,100. For most people, regardless of salary, the increase is a considerable amount of money, even when it is spread out over the 52-week year.

Offsetting the increase with retirement contributions

The good news is that you can offset some of that tax hike by contributing more money to your retirement accounts. As long as you focus on tax-deferred contributions, you can lower the amount of income that gets taxed.

Let’s say you get paid $50,000 a year, but you don’t contribute any money to a 401(k) account. The payroll tax hike means that you will pay $3,100 by the end of the year. If you were to contribute $17,000 to a 401(k) account (the current maximum), your payroll tax burden would drop to $2,046. That’s actually less than you would have paid in payroll taxes before the holiday expired.

Granted, not everyone can afford to contribute $17,000 to a retirement account every year. If a 2 percent tax hike is killing you, then you probably don’t have enough excess money to fill your 401(k). Still, this shows that it is possible to lower your tax burden by making tax-deferred contributions.

Other ways to offset the tax burden

You can also look at other retirement and savings plans that don’t tax your contributions. If you have children, start putting money in a 529 plan that gives you tax advantages while helping them pay for college. Also, consider investing in a traditional IRA rather than a Roth IRA. Traditional IRA contributions don’t count as taxable income.

Depending on how much money you have and how much you have to spend just to survive, you could significantly reduce the burden of this tax hike by increasing your retirement contributions and making other smart moves with your money. Even if you can’t completely eliminate the hike, you can soften the blow a bit. Plus, you get those tax-free contributions back when you retire.

Jeff Rose is a Certified Financial Planner who writes about financial planning topics at Good Financial Cents. His latest project, The Debt Movement, aims to help people pay off $10,000,000 of debt in 90 days. You can join the movement and get a chance to earn some of the $10,000 debt scholarship money by visiting DebtMovement.com.

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