The following was published and written at www.DaveRamsey.com.
The new year arrived, goals were set, and financial aspirations were locked as you set out to take advantage of your greatest wealth-building tool: your income.
When you finally got your hands on that first paycheck, you no doubt registered one of three emotions: anger, confusion or ignorant bliss. Well, we’re here to clear things up with straight facts about the recent tax change and what it means for you and your family.
As the so-called “fiscal cliff” deal came to a close, many Americans were relieved to learn that Congress extended income tax breaks on individuals earning less than $400,000 per year. It sounded like the average person wouldn’t be affected.
Unfortunately, the details aren’t so obvious.
In 2011, Congress temporarily reduced the Social Security payroll tax from 6.2% to 4.2%, which meant extra money in the pockets of the American people and, ultimately, the marketplace. It was designed to help boost the economy.
That tax cut expired on December 31, 2012. The change back to a 6.2% Social Security payroll tax rate took place immediately. If your most recent paycheck seemed lacking, that’s why.
What This Means
At first glance, a 2% tax increase might not look like a big deal—hence the ignorantly blissful among us. When we do the math, though, this minimal cut does make a difference.
Take the average American household income as an example. For families earning $50,000 per year, the expired Social Security tax cut is essentially a $1000 pay cut. That works out to roughly $40 every two weeks.
What, really, does that $40 represent? A cable bill? A dinner out with the family? It could be savings, a debt payment, a bag of groceries, a cell phone bill, a small tank of gas, a haircut, or even babysitter money. It’s opportunity cost in action—only now you don’t get the opportunity to decide.
Sometimes hope comes from encouragement. Other times it’s a result of facing reality, determining what you can actually do, and getting to work. Now, more than ever, you need a plan. The world is not ending, but storms are coming. With looming uncertainty about our national debt ceiling and pending changes—yet again—on the tax rate, it’s time to get serious.
- Living without a budget stops today. You should write down your income at the beginning of the month and assign each dollar a name. For now, figure out the money you have left to spend until your next paycheck and where it should go. It might be tough to follow at first.
Fortunately, as people get a handle on the budget, they often feel like they’ve gotten a raise. Find just 2% of needless spending to rein in and your efforts will be worthwhile. In fact, research shows that people who do a zero-based budget pay off 19% more debt and save 18% more money than those who don’t.
- You will have to make some cuts. Look at your current spending habits to determine where you can trim 2%. The point here is to be intentional and make the decision ahead of time. It’s tough to choose wisely when your stomach is grumbling and your favorite restaurant is staring at you from behind the stop sign.
Sure, $40 isn’t a huge amount, but that makes it sneaky. Save yourself the heartache that comes from ignoring change. Go ahead and make some cuts now. Agree on it with your spouse and warn the kids so no one is surprised.
As Dave teaches in Financial Peace University, your first job is to take care of yourself and your family. Developing a solid plan for your money puts you in control of every dollar you bring home—a power you can’t afford to pass up.