Understanding the 2011 Social Security tax cut

A decrease in Social Security taxes could make now a good time to review your retirement plan deferral percentage.

This year brings good news for American workers. In 2011, we'll receive a 2 percent reduction in our Social Security payroll taxes.

When Congress voted to continue many of the Bush-era tax cuts into the new year, they also included an additional Social Security tax break for 2011. As a result, FICA taxes — sometimes referred to as Social Security taxes — will move from 6.2 percent to 4.2 percent for this year only on the first $106,800 in earned income.

That means American workers will pay only $42 in FICA taxes per $1,000 of pay (up to the $106,800 Social Security taxable wage cap) instead of $62 per $1,000. Because a person's future Social Security benefits are based on his or her career earnings, the Internal Revenue Service (IRS) has stated that this 2011 tax break won't affect a worker's eventual Social Security benefit.

Impact on take-home pay

The reduction doesn't guarantee a 2 percent increase in take-home pay, unfortunately. That's due to other deductions that could change (such as increases in insurance rates, state taxes, etc.), as well as the expiration of the Making Work Pay credit.

However, the tax cut does serve as a good reminder to take a look at your taxable income and your current retirement plan deferral level. If your take-home pay has increased, for instance, that provides a great opportunity to set aside more for retirement.

Even a small increase in your retirement plan deferral can potentially have a big impact on your retirement savings over time. The chart below shows the possible effect a small increase in pre-tax contribution to the plan can have on retirement savings for a worker with a $40,000 salary.

Annual Contribution	Reduction in Take-Home Pay Per Week	Projected Savings at Retirement
1%	$5.77	$7,065
2%	$11.54	$14,130
3%	$17.31	$21,195
5%	$28.85	$35,325

This example is for illustrative purposes only. The assumed rate of return in this chart is hypothetical and does not guarantee any future returns nor represent the return of any particular investment option. The chart assumes a 25 percent tax bracket that includes local, state and federal taxes. Assumes $40,000 in annual income, 10 years to retirement and an annual 8 percent rate of return. Reduced take-home pay is accurate for the initial year and would change based on participant's annual pay. Chart assumes a 4 percent annual pay increase.

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