A Payroll Tax Cut Could Have a Major Impact on Your Retirement
August 21, 2020 Author: Tess Downing, MBA, CFP®, Complete View Financial
With a presidential election looming just a few short months from now, chatter about a payroll tax cut is invading the internet. There’s a lot of misinformation, so we’ve compiled a factsheet for you to explain tax cuts, deferrals, and potential issues with social security.
The current tax rate for social security is 12.4%. Employers pay half of that. Self-employed individuals pay the entire tax themselves. There’s also a Medicare tax of 2.9%, but for this article we’re going to focus on the social security portion of the payroll tax.
A Payroll Tax Deferral is Not a Tax Cut
The executive order issued by the Trump Administration this week is a payroll tax deferral, not a cut or exemption. It’s also voluntary. Employers can choose to continue withholding and paying payroll taxes on a regular schedule. Workers would continue to pay on their end.
Employers who take advantage of the deferral are essentially getting a no-interest loan from the government. That’s great for short term cashflow, but risky for the government. If the business defaults on their obligation or becomes insolvent, it impacts social security.
The Current State of Social Security
In 2010, the Social Security Board of Trustees (SSBOD) released a report saying benefits would be fully funded until 2037. Beyond that date, the SSA could pay 76% of benefits owed for another seventy years. That’s based on the assumption that tax revenue remained constant.
That same report recommended an increase in the social security tax to 14.4%, which would make it possible to pay full benefits until 2085. An additional increase would be needed to go beyond that. Sustainable solvency was their primary concern. That was ten years ago.
Your 401(k) Could Benefit from a Payroll Tax Cut
Social security might take a hit, but the value of your 401(k) could go up if a payroll tax cut is approved this fall. Major corporations, some of which you’re invested in, would experience a significant cash windfall. Amazon alone paid $2.4 billion in payroll taxes in 2019.
Unfortunately, the effect on the stock market may be short-term. If tax cuts are temporary, investors will not be as active. The election will cause major market indexes to fluctuate. It’s a complex picture, one that you should discuss with your financial advisor.
Self-Employed Workers need to Plan Carefully
On the surface, service providers and commissioned salespeople seem to be the big winners if a payroll tax cut is enacted. The savings on social security tax alone are an additional 12.4% back in pocket. That’s how much less you have to come with for your next quarterly filing.
On the downside, workers with a variable income stream tend to be less vigilant about retirement fund contributions. A social security check after age sixty-seven might be a significant portion of retirement income. Payroll tax cuts could potentially take that away.
Long term planning with an income that fluctuates is difficult. If you are in that position, don’t view the tax cut as found money. Use the extra funds to beef up a Roth IRA or an investment portfolio. Our team at Complete View Financial can help you with that.
Business Owners have Some Decisions to Make
Eliminating or cutting payroll taxes will increase profit margins. This opens up options for investing, business expansion, or enhancing employee benefit packages. If the payroll tax cut becomes a reality, business owners will be faced with some difficult decisions.
Taking advantage of the current payroll tax deferment option could be an opportunity to plan for the future. Spend the next few months experimenting with different financial options. Don’t do anything too risky, though. You’ll need to pay those taxes eventually.
Holistic Financial Planning Eliminates these Concerns
A proper, holistic financial plan can alleviate most of the concerns outlined in this article. Social security and the equities market will be impacted by a payroll tax cut. Savings, insurance, and the bond market will see minimal changes. Finding the right balance is critical.
Complete View Financial offers investment portfolio management, financial analysis, and financial planning for individuals and business owners. There’s a lot that might happen in the next six months. Reach out to us today so you’re ready for anything.