There were two recent developments that have locked in 2 additional bonuses for 6 figure earners in 2011. Aside from the framework tax deal Obama announced last week which left tax rates alone for all earners, the payroll tax reduction of 2% and the locked cost-of-living adjustment on Social Security means the cap at which employees pay into the system remains fixed for the third year in a row. Let me explain how both of these translate into a significant bonus for high earners next year – and some suggestions on what to do.
Payroll Tax Holiday
Since the normal employee payroll tax is 6.2% and it will be reduced to 4.2%, this amounts to a $2000+ bonus in 2011 (after-tax money). Once hitting the FICA limit below that tax is phase out anyway, but that’s an extra $2000 on income earned even if you don’t make that much.
2011 FICA Tax Limit
Just like 2009 and 2010, the limit at which employees stop contributing toward this will be $106,800. So, for any earnings after $106,800, you’re essentially get a “bonus” of 6.2% of your earnings in your paycheck through the remainder of the year. Since generally, wages have increased over the prior years, but this cap hasn’t increased, this bonus is increasing each year.
Example Earner – $130,000 in 2011
This earner would see the full 2% additional bonus on the first $106,800 earned ($2136) and then a 6.2% bonus on the income earned from $106,800 up to $130,000 ($1438) for a total bonus of $3574 in 2011.
What To Do With Your Bonus?
A nice way to avoid squandering this one-time windfall would be to adjust 401(k) contributions or IRA contributions to reflect the specific increase in the monthly earnings you’ll see as a result of the payroll tax break. This way, it’s invisible to you, you’re not tempted to spend it and it basically went right into your retirement account. You’ll be able to look back in 20 or 30 years (if you’re young) and say you took that unexpected one-time bonus and parlayed it into a $35,000 or so bonus in retirement.
If you’re carrying high interest credit card debt, this extra money would be well-spent in paying that down. Perhaps you want to pay down your mortgage early or invest in your side business. Or perhaps you’re going to be a “patriotic American” and spend it stimulating the economy :>
Regardless of whether you make six figures or not, you’ll be enjoying at least the payroll tax deduction next year.
What Will You Be Doing with Your Bonus?