Payroll Tax Cut Extended For 2012: Increase 401k Contributions?

Congress has just passed a bill which the President has promised to sign that includes an extension of the 2% payroll tax cut for the rest of 2012. Specifically, the employee portion of the Social Security tax is reduced to 4.2% in 2012 instead of the standard 6.2%. The employer portion remains unchanged at 6.2%. The Medicare tax remains unchanged at 1.45% each for employers and employees. This tax cut has already been in effect since the beginning of 2011 and was scheduled to end at the end of February 2012 before this most recent extension.

For example, someone earning $50,000 annually will see increased take-home pay of $1,000 spread out evenly over a year of paychecks. The limits on wages subject to Social Security tax is $110,100 for 2012, so the maximum savings per person is $2,202. You can verify this tax cut for yourself by checking your most recent paycheck stub. Divide the Social Security tax line by your Gross Pay line. It should be either equal or less than 0.042, or 4.2%. (It might be less than 4.2% due to items that are exempt from SS tax like flexible spending account contributions.)

Spend it, or save it?

The idea behind this tax break is to provide a small, steady increase in income that you’ll hopefully spend quickly and thus stimulate the economy. Even though $1,000 sounds like a lot, when it comes to you as $40 every bi-weekly paycheck, you tend not to notice it. Surveys confirm that the majority of people don’t even know this tax cut exists after enjoying the benefits for a year.

However, if you’re happy with how you’ve already stimulated the economy and would like to put something away to invest and spend later, this might be a good time to increase your savings rate instead. Remember that your savings rate is the most important factor in whether you’ll be able to retire early (or perhaps ever).

Since this tax break comes automatically every paycheck, it makes sense to “pay yourself first” by putting it aside immediately via automatic savings. Instead of mindlessly spending like they want you to, mindlessly save it instead. 😉 If you have a 401(k) or similar employer-sponsored retirement plan, why not increase your contribution rate by 2%, and see if you notice it for the rest of the year? Of course, if you have high-interest debt and some extra willpower, perhaps you should put it aside each paycheck and pay that off instead. You can also use direct deposit or automatic transfers to send money over every paycheck to an online savings account.

Sources: Philadelphia Inquirer, Associated Press


  1. I’ll need to save it. Tax cut? That’s a laugh. It means there will be less Social Security for my retirement, whenever that might be…..

  2. Is it any wonder that an organization that is $14Trillion in debt on the books and another $40Trillion in debt off the books would encourage people to spend money wastefully that they could otherwise save?
    Maybe we should all be just like the government, go out and spend our extra 14 cents on politically expedient earmarks, democracy where people don’t want democracy and our own harassment and intimidation by all the usual suspects.

  3. The whole point of this is to stimulate the economy…..This is one of the reasons people target the well off to pay more……. I am a firm believer in saving, but tax policies like this dont work because people like to save in tough times.

  4. I bumped up my contribution to the 401(k) at the beginning of the year, so that’s already been done. I suppose if they would have failed to extend it, I would have had to reduce it back down, but I knew there was no way that was going to happen in an election year.

  5. I’ve been putting mine religiously to my mortgage (just pretending like it is not there – so it won’t bother me when it goes away. $3400 over 2 years?).

    Though I personally enjoy this kind of tax break (seeing it each and every month) I do think it is politically foolish. As you said, most people don’t even notice or know about it, but I can assure you that they will notice when their paycheck decreases by 2% next year. & then everyone will be complaining about the “tax increase.” I also wouldn’t be surprised if it gets extended indefinitely by politicians who don’t want to be the one to “Raise worker’s taxes.” Temporary tax increases AND tax breaks have a funny way of lingering for many years or decades. (But don’t worry, they get you somewhere else, like AMT. They’ll just tax us in a stealth way to get the money back).

  6. I’m indifferent to the payroll tax cut. Sure, it’s nice to have, but at the expense of Social Security. I’m beginning to wonder if it’ll ever return, because the longer they prolong it, the harder it’ll be to reimplement.

    Right now my more immediate concern is gas prices. They’re going up again– fast I might add. It’s $4.09 to $4.15 where I live. I still believe gas prices is what ruined the economy in the first place. I’d much rather see something done about that than payroll taxes. I almost wish I lived in an area where they pay the national “average” price, because I’ve never seen it that low.

  7. I agree with JustMe, I don’t think a lot of people are realizing the benefits of the tax cut with raising cost like gas/food etc… eating the ‘savings’

    Here in Illinois is even worse: our income tax rate increased by 66% last year. For people that take public transportation to work, Rail fares increased 30% this month…

  8. LargeTalons says:

    Contrary to popular belief, the SS and Medicare trust funds say absolutely nothing about the future “solvency” of SS and Medicare. The trust funds are just numbers in a book. Do you know what would happen if the trust funds reached a zero balance. Absolutely nothing. SS and Medicare will continue to be funded by the government. The only reason the trust fund gimmic exists is to keep track of the balance between the regressive FICA tax and payments made to FICA beneficiaries. You know what they do with the surplus of funds that have poured into the trust funds over the decades? They get held in treasury securities, which is a fancy way of saying the government spends it on other stuff. The are only two ways SS and Medicare can go bankrupt. One is if the federal government is invaded and the US no longer exists (in which case I’m guessing you will have bigger problems to worry about than whether or not you’ll get SS). The other is if you elect people who terminate the programs on purpose.

    The payroll tax cut is exactly the kind of thing that needed to be done, except that sadly, it doesn’t go far enough. The FICA tax is a regressive tax that shouldn’t even exist in the first place (read this:

    Secondly, anyone who tells you that SS and Medicare are going to bankrupt the government is either lying to you, or has no idea how our monetary system works, but most likely both. The truth is that a sovereign nation with its own free floating currency can never go bankrupt, it’s impossible. Here’s why:

  9. First of all, “LargeTalons” is an awesome handle.

    Second of all, I would like to point out that, from an economic perspective, saving money is just as beneficial as spending it. No matter where you put your money, somebody will be using it. If you put it in the bank, the bank will lend it out. If you buy stock, the company will pay its employees with it. The idea that spending money stimulates the economy while saving it somehow doesn’t is a fallacy.

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