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First money challenge of 2011: Best use for pay hike

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NEW YORK — It’s almost like Oprah is taking over payroll departments nationwide: Everyone is getting a raise!

Last month’s tax deal included a 2 percent decrease in payroll taxes for workers who pay into Social Security. That means most people will see their paychecks increase by the end of January. However, some federal workers don’t pay Social Security taxes.

For a typical worker, with taxable income of about $50,000 a year, the payroll tax holiday means a $1,000 bump over the course of the year, or about $83 per month. But the math behind the actual increase likely to appear in paychecks is a bit complicated.

That’s because the payroll tax holiday is taking the place of the Making Work Pay tax credit, which expired Dec. 31. Most of the workers who received that $400 credit already benefitted from reduced withholding. As a result the typical impact from the payroll tax holiday for those workers will be a raise of about $50 per month.

Those will higher salaries will get a bigger monthly increase. The tax cut only applies to the first $106,800 earned, because that’s where Social Security contributions stop, noted Melissa Labant of the American Institute of CPAs.

Individuals who earned more than $95,000 weren’t eligible for the Making Work Pay credit, so they will see a full 2 percent increase reflected in their paychecks.

Anyone with taxable income of less than $20,000 per year will see a somewhat smaller paycheck. That’s because the Making Work Pay credit was more than 2 percent of their earnings.

It will be easy to let any extra money slip away through unplanned spending, particularly because the savings will come throughout the year rather than in a lump sum. That’s actually what lawmakers are hoping for, in a sense. "Every government tax break is intended to stimulate the economy in a way, so the government likes to see you go out and spend that money," said Paul Golden of the National Endowment for Financial Education.

But while it may not sound like much, $50 a month can go a long way toward cutting credit card debt or helping to build an emergency fund. "A little money can make a lot of difference, if used properly," said Gail Cunningham of the National Foundation for Credit Counseling.

Here are five possibilities for using the money wisely:

Avoid a "holiday hangover" at this time next year.

Use the money to establish a holiday fund for gift giving, Golden suggested. Although your bank may no longer offer an old-fashioned Christmas club, there’s no reason you can’t stash the money in a designated account. Setting aside a small amount each month will put you in a great position for celebrating without worry.

Park cash for car maintenance.

Think you’ll need new tires soon? Do you scramble for cash when the auto insurance comes due? If you’re a faulty transmission away from financial disaster, think about saving this monthly windfall for those bills you know are just down the road by creating an account for your wheels.

Invest in yourself.

Although layoffs aren’t happening in droves anymore, the job market is still extremely tight. Adding a certification or degree to your résumé could help you score a promotion or help you qualify for a new position elsewhere.

Resolve to stay healthy.

If you skimp on health care because of the cost, stash some cash to cover co-payments for doctor visits or prescriptions. If you have a high-deductible health insurance plan, using your tax break to fund a health savings account will help you save twice, because HSA funds are tax free.

5. Create a fund for family fun.

If you avoid taking the kids to an amusement park or ballgame because you never seem to have the cash, try earmarking some of your tax break for good times. Get the kids involved in planning an excursion and you’ll create anticipation. That should increase your motivation and make it easier to save.



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