As a way to stimulate the economy, Congress included a provision in the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 that reduces the Social Security taxes you will pay in 2011by two percentage points.

Unless you work for the government or qualify as a “student employee”, your employer is generally required to withhold Social Security and Medicare taxes from your salary. The 2010 rate was 6.2% for Social Security taxes and 1.45% for Medicare taxes – for a combined rate of 7.65% for these two taxes.

Your employer then matches the Social Security and Medicare taxes withheld from your pay. On each dollar you earn, therefore, the government receives 15.3 cents. Please note that you also pay federal and (most likely) state income taxes on these earnings.

As we discussed in ourNovember 2010 newsletter, there is an annual limit to your wages and self-employment income subject to Social Security taxes. Since 2009, this limit has held steady at $106,800. While you don’t pay Social Security taxes on earnings in excess of this threshold, expect to pay Medicare taxes on every dollar you earn.

Now for this year’s tax break. For 2011 only, employers will reduce the Social Security taxes withheld from their employees’ pay by 2 percentage points. The 2010 rate of 6.2%, therefore, drops to 4.2% for one year only. This means that anyone earning $50k per year will have an extra $1,000 to save or spend in 2011. People earning $106,800 or more will see their take-home pay increase by $2,136, or $178 per month.

This reduced rate applies to the employee-portion of Social Security only. Employers will continue to submit their matching contributions using the 6.2% rate for Social Security and 1.45% for Medicare. (So I guess the employer’s 7.65% payment can no longer technically be referred to as a “matching” contribution.)

Self-employed individuals will see a 2% decrease in their “self-employment tax” rate as well. The pre-2011 rate of 15.3% will drop to 13.3% for 2011 only.

Will the government succeed in stimulating the economy by borrowing an estimated $110 billion to reduce 2011 Social Security taxes by two percentage points? Only time will tell.

Privatize Your Social Security Savings

When George W. Bush was in office, his team suggested partially privatizing social security. His plan was to provide employees paying into the Social Security system with the option of diverting a percentage of his or her Social Security tax withholdings into a personal investment account.

Unlike your accrued benefit maintained by the Social Security Administration, a privatized social security account would contain investments that actually accumulate in your name. The funds in that account would be available to supplement your retirement income, and then, upon your death, any money remaining would pass to your heirs. Why not take this opportunity to invest 2% of your 2011 gross salary, up to $178 per month, into an IRA, annuity, or savings account?

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