Tuesday, December 14, 2010

Second Chances

It looks like we the people will get a second chance to get our finances in order. Before year-end the tax bill that extends the Bush tax cuts for two additional years plus a payroll tax deduction of 2% should make it into law. This provides a massive opportunity for all of us to shore up our financial position.

The proposed tax bill will keep things like the child tax credit at $1,000 per child and lower tax brackets for income, qualified dividends, and long-term capital gains. In addition to the long list of extended lower taxes, the payroll tax will be reduced 2%. The payroll tax consists of Social Security (6.2%) and Medicare (1.45%). Your employer pays another 7.65% as well. The payroll tax deduction is a reduction of the Social Security portion from 6.2% to 4.2% for the employee only. This is a $1,000 tax deduction for someone earning $50,000 per year. You will see the additional money on each paycheck. If passed, the payroll tax deduction is for 2011 only.

Your Social Security benefits will not change due to the reduced payroll tax. The government will fund the Social Security Trust Fund from the general budget which means they will borrow the money to pay the trust fund.

Many Americans still have a personal finance mess on their hands. Years of overspending lead to a negative savings rate and high debt levels. The current low tax environment coupled with low interest rates is the perfect opportunity to pay down debt as fast as possible. It is only a matter of time before interest rates climb. Taxes must go up eventually to balance the books in Washington.

The debate about higher taxes is just that, a debate. The government is not taxing enough to cover Social Security, Medicare, Military, and interest. Defaulting on the national debt is out of the question as it would turn the U.S. into a third world country; Social Security and Medicare are sacred cows; and you can cut the military only so far before national security is at risk. Ergo, taxes will rise at some point in the future, whether they be income taxes or a value added tax.

It is easier to pay down debt when tax rates are low. When you keep more of what you make there is more available to reduce debt.

It is easier to pay down debt in a low interest rate environment. Payments apply more to debt and less to interest in such an environment.

If you have little or no debt, now is the time to build reserves for the day when interest rates rise. Tax policy can help you build that reserve faster and bigger.

Opportunity is knocking once again. It is wise to take advantage. The opportunity will not last forever.

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