What to do with bigger paycheck

The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 temporarily reduces the Social Security portion of the FICA payroll tax from 6.2% to 4.2%, which means an increase of 2% in your pre-tax income. (You should have noticed a larger paycheck this year.) For example, if you earn $50,000 a year, you can expect to see an additional $1,000 in your pay, before income taxes, for 2011.   

This money would have been used for retirement through the Social Security program. Instead of spending it, consider saving more for your own retirement by contributing to a Roth IRA.  Although some employers are encouraging employees to contribute the money to a supplemental retirement account (SRA), a Roth IRA is a better choice for a couple of reasons.   

1) In retirement, all of your defined benefit pension income (URS or other pension) and withdrawals from a defined contribution plan such as a 401(k) or 403(b) (TIAA-CREF, etc.) will be subject to income tax at rates that are very likely to be higher than today’s ultra low tax rates. Income tax rates WILL be higher in the future, despite the current anti-tax rhetoric, due to the large federal deficit and entitlement programs (your SS retirement checks).  Because a Roth IRA is funded with after-tax dollars (you don’t get a tax deduction for your contribution), withdrawals in retirement will be tax-exempt. So it is better to pay income taxes now when rates are low in order to avoid taxes on part of your retirement income (from Roth IRA) in the future.

2) You should invest your retirement savings where the investing costs are lowest AND where you don’t pay a commission to a sales person. Some of the SRAs offered through employers charge commissions and high fees. Vanguard index mutual funds and the Schwab Total Stock market index fund (more diversified than the S&P 500) charge the lowest fees that my students and I have been able to find.  Vanguard requires $3,000 to open an IRA but Schwab lets you start with as little as $100. 

For details and specific suggestions, consult the January/February issue of Money magazine or the link to the Money 70:  http://money.cnn.com/magazines/moneymag/bestfunds/ a list of 70 low cost mutual funds and exchange traded funds (ETFs) along with a clear explanation of the choices. Go for the low expense ratios.  Open a Roth IRA with your SS tax savings and do it NOW!
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What to do with bigger paycheck
What to do with bigger paycheck
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