Principal Says Payroll Tax “Holiday” an Opportunity to Save

Those who have been following the debate over Social Security reform may be surprised (see Panel Recommends Cuts in Employer Health Care Tax Treatment ) to learn that next year we’ll actually be putting LESS money aside, with most American workers getting a 2% bump in their take home pay (those above the maximum FICA withholding limit will get 2% up to the amount against which withholding is taken), courtesy of legislation just signed into law by President Obama as part of that tax compromise legislation (see IRS Releases Pay Withholding Change Guidance).  

The Tax Extension Bill provides a Social Security “tax holiday” by decreasing the current payroll tax rate from 6.2% to 4.2% for one year. 

Now, the economists (and politicians) are probably counting on you to spend that bump in take-home pay, but the Principal says that the new Social Security payroll tax “holiday” could actually be an opportunity to bolster retirement savings, albeit in your personal 401(k) or 403(b) account.  After all, there is no “holiday” from retirement savings.  

The Difference 

The Principal Financial Group says American workers who save rather than spend that extra 2% could potentially make a “significant difference” in their retirement nest eggs over time. They cite the example of a 30-year-old earning $50,000 a year who defers an extra 2% into his or her 401(k) account over the next year, and note that that would boost the weekly 401(k) contribution by a little more than $19. However, that amount could potentially grow to more than $16,600  by retirement at age 66 (the normal retirement age for Social Security is already over 65, of course, on its way to 67). 

“For Americans who can afford it, why not just put part or all of that 2 percent tax cut into your 401(k) or 403(b) account? It’s money you aren’t used to spending anyway,” said Greg Burrows, senior vice president, retirement an investor services at The Principal.  “It may be just the amount to get closer to saving between 11% and 15% of pay . We believe most retirement plan participants should be saving in that range–including employer match– over the course of a career to have adequate income at retirement.”   

The Principal also notes that workers who are 50 years and older and already maxing out on their retirement plan contributions, could use the 2% as part of their catch-up contribution.