Payroll Tax Deferral: What to Know and Uses for the Money
As the coronavirus pandemic continues to impact Americans’ financial health, the federal government has taken action to provide additional relief beyond the measures covered under the CARES Act. In early August, President Trump signed a number of executive actions, including one that would “allow employers to defer payment of employee-side Social Security payroll taxes through the end of 2020 for Americans earning less than about $100,000 annually.”
This payroll tax holiday, which is set to last from September 1 to December 31, would mean that if you’re working and within the income limits specified by the executive action, you’d be temporarily excused from paying the 6.2% Social Security tax each payday. That could put money back in your pocket in the short-term.
But it’s important to be aware that you may be required to pay any deferred payroll tax back next year, though the specifics on how this would work haven’t been established yet. Here’s what we know so far.
Using the Payroll Tax Deferral to Your Advantage
If you’ve been working for awhile, this likely isn’t the first time you’ve seen a payroll tax cut. In 2011, on the tail end of the last recession, Congress approved a 2% Social Security tax to help boost the economy.
An important difference with respect to the Payroll Tax Deferral currently put forward is that unlike the last one, workers will most likely have to pay back any taxes that are deferred at a later date. So above all, you will want to make sure that you have enough cash on hand to cover the expense when that day eventually comes.
However, if you are comfortable with your ability to pay those taxes in the future and want to take advantage of your higher paycheck in the near term, here are some smart ways you can put this extra money to use.
Getting Caught up on Bills
Even if you’re still working, it’s possible that your paychecks may have been affected by the coronavirus pandemic if your employer was forced to reduce your hours. Working less each week means a smaller paycheck, which could put more of a squeeze on your budget.
If you’ve fallen behind on some of your bills, such as utilities, rent, or mortgage, you could use the extra money from the payroll tax deferral to catch up. When multiple bills are past due, consider how to best prioritize them. For example, getting caught up on the rent may take precedence over paying your overdue credit card bill.
And if you’re still struggling financially despite working and benefitting from the payroll tax deferral, it’s a good idea to stay in touch with your creditors and billers. They may be able to help you work out repayment plans, lower your interest rates, waive late fees, or temporarily pause payments altogether until your finances stabilize.
Using the Money to Grow Your Emergency Fund
If you’ve been able to keep current on your bills throughout the pandemic, you might decide to turn your attention to growing your savings instead. As the current crisis has shown, having emergency savings in place is more important than ever in case of an unexpected illness or job loss.
Not sure where to save? SoFi Checking and Savings® vaults offer a simple way to earmark the extra money in your paychecks for emergency savings. You can set up a vault extension inside your SoFi Checking and Savings account specifically for emergency savings or other savings goals and earn interest on the cash you’re tucking away. And if you need to tap into your savings, you can easily move money from your vault to your spending balance.
Paying Down Debt
High-interest debt can throw a wrench in your financial plans if you have bigger goals you’re working toward, like saving and investing for retirement. The more you pay in interest, the longer it can take to pay those debts off. And even if you have lower-interest debt, such as federal or private student loans, interest charges can still add up over time.
If you expect to have some extra money coming your way because of the payroll tax deferral, applying it to your debt could be a no-brainer. One way to make the most of it is to make your debt less expensive first.
For example, if you have high-interest credit card debt you might consider consolidating it with a low-interest personal loan. This way, you’ll have just one debt payment to manage and you can save money by paying a potentially lower rate. SoFi offers personal loans with low fixed rates, and it’s easy to get a free rate quote online.
Student loan refinancing might also be worth considering if you have private student loans. With student loan refinancing from SoFi, for instance, you may be able to refinance your loans at a fixed or variable rate, with no hidden fees. However, it is important to note that if you refinance your federal student loans, you forfeit any federal benefits that come along with them.
Regardless of which type of debt you have, reducing the interest rate can help the extra money you’re applying from your paychecks stretch even further.
Investing for the Future
If you’ve got your monthly bills, emergency savings fund, and debt repayment under control, a fourth option for using the payroll tax deferral to your advantage may be investing for the long-term. There are different ways you can do this.
For instance, if you’re already contributing to your employer’s 401(k), one option might be to temporarily bump up your contributions for the year to reflect the extra money in your checks from the tax holiday. Or you might choose to funnel the extra money into an individual retirement account, which may help you grow your money while enjoying some tax benefits.
If you’re just getting started with investing, however, you might want something a little less complicated, and a taxable investment account like SoFi Invest® could be a great option, depending on your financial situation. Even for investors who may not have a lot of money to invest, getting started investing in stocks and exchange-traded funds (ETFs) can be done with as little as $5 with SoFi fractional shares. It’s an easy way to build a portfolio using fractional shares if you don’t have a big chunk of money to put into the market all at once.
Some Payroll Tax Questions Are Still Unanswered
On August 28, the IRS issued guidance clarifying several aspects of the tax holiday. Companies may stop withholding Social Security tax from September 1 through December 31, but workers will have to pay these taxes by the end of April 2021. The policy only applies to workers earning $4,000 on a bi-weekly basis, or $104,000 per year (gross).
However, there are several key aspects of the payroll tax deferral that remain uncertain. For instance, it’s up to employers whether they opt in to the policy. If your employer chooses not to, then you may see no impact from the tax holiday at all.
It’s unclear what would happen if an employee leaves their job before the deferred taxes are paid back in April 2021. The guidance states that employers may “make arrangements to otherwise collect the total applicable taxes from the employee.” A worker in this situation would potentially have to pay all taxes owed in a lump sum.
And finally, it’s important to note that this payroll tax deferral only helps working Americans. If you’re one of the millions of people who are unemployed because of the COVID-19 pandemic, you won’t see any benefit at all from this executive action.
Keeping Your Financial Plan Up-to-Date
When a situation like a global pandemic comes along and causes massive financial ripple effects, it’s important to be prepared. That means having a financial plan in place that you can stick to when the economic outlook seems uncertain.
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