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How to Maximize Your New Tax Credit This Year

We're thrilled to present this smart Learnvest story here on Savvy!

It is a truth universally acknowledged that a person in possession of a tax credit generally feels pretty damn fine. So, let the good feelings ride: the government started a new tax credit at the beginning of this year, and you’ve probably been seeing it in your paycheck already. Cue the sad violins: there’s a catch. This tax credit means that you’ll be paying less to Social Security — and many experts already speculate that the program is crippled. Paycheck contribution or no, don’t count on Social Security to do you any favors when you hit retirement.

Dealing With The Flip Side.

The government is giving you this tax credit in tiny installments in an effort to encourage your spending it without noticing (those sneaky bastards!) — but don’t forget to look out for number one. So, this year, plan to sweep that extra money into your retirement account. If you’ve been a good girl and already maxed out your retirement savings for the year, use the rest to shore up your emergency fund.

Find out how much you'll be getting after the break.

How Much Are We Talkin’?

Regularly, you pay 6.2% of your income to Social Security. In 2011, the government has reduced that amount to 4.2%, essentially giving you an extra 2% in your paycheck. This is capped for an income of $106,000, so the top amount you could get back from the tax credit is about $2,100.

Calculating Your Windfall.

To figure out how much additional money you’ll bring in this year, multiply your gross salary by 2% (calculate using $106,000 if you make more than that). That’s how much extra you’ll see. Now, this new credit replaces last year’s Making Work Pay credit, under which most working adults received a $400 tax credit. Subtract the number you just found by $400 to figure out how much you’ll wind up with above and on top of the credit from last year. For example:

If you make $50,000 per year:
$50,000 x 0.02 = $1,000 extra
$1,000 – $400 = $600 extra after taking the old expired credit into account
If you invested that $600 in a Roth IRA, you could make over $4,000 by retirement.*
*If you make an inflation-adjusted 8% in market returns, are currently 25, and will retire at age 65.

Source: Thinkstock
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