There are four major ways that your income can be taxed as a civilian or military: Taxable, Tax-Deferred, Tax Free or free money retirement plan contributions matched by Your Employer. Three of the four are beneficial, including deferring your income taxes for any period of time as in your TSP, 401(k), or annuity. With the exception of a Roth, which is a pre-tax plan, eventually taxes will have to be paid upon retirement or withdrawal. The President’s memo, explained below is designed primarily to help business owner’s cash flow and capital investments during these challenging times. Normally, an employer, pays 6.2% in Social Security contributions for themselves and their employee for a total of 12.4%. These contributions are waived for the remainder of 2020. This excludes Medicare.
This represents a unique, extraordinary opportunity for savvy savers to ramp up retirement, pay down debt, or establish an emergency fund. It also comes with a hitch.
Unless, this deferral is postponed or made permanent, it will be need to be paid back automatically through LES deductions next year during the first four months of 2021. Below is the DFAS explanation and a couple of planning suggestions for civilians and enlistees. Private sector employers’ employees can opt out with employer discretion.
In order to provide relief during the COVID-19 pandemic, a Presidential Memorandum was issued on August 8, 2020 and guidance followed from Internal Revenue Service on August 28, 2020, to temporarily defer Social Security (Old Age, Survivors, and Disability Insurance (OASDI)) tax withholdings. This change is effective through the end of the 2020 calendar year.
Military Members - Effective for the September mid-month pay, DFAS will temporarily defer the withholding of your 6.2% Social Security tax if your monthly rate of basic pay is less than $8,666.66. If your monthly rate of basic pay is at or above this threshold, your social security tax withholding will not be affected by the temporary deferral. Military members can use their August or prior LES as a good reference for their typical Social Security tax amount. The Social Security tax is labeled as “FICA-SOC SECURITY” on the LES and is calculated as 6.2% of basic pay.
Civilian Employees - Effective pay period ending September 12, 2020, DFAS will temporarily defer your 6.2% OASDI tax withholding if your wages, subject to OASDI are less than $4,000 in any given pay period. Employees can use the “Taxable Wages” on the LES as a good reference for whether they will have OASDI tax deferred.
The OASDI deduction is found on your LES under the deductions tab/section
What to do with Payroll tax Deferral:
- Go online to IRS.gov and amend your W-4 using the free IRS TAX withholding estimator now and at the beginning of the New Year. This takes about 20 minutes, with proper forms like your LES, brokerage and bank statements and a copy of last year’s taxes. This will give you an idea as to whether to increase withholding or not for 2020. Remember that next year we will be using CPAs, Tax Attorneys, and Enrolled Agents on base free during tax season but the time too amend your W-4 if necessary is NOW.
- Open up a three month CD or Money Market Mutual Fund for the remainder of the year and earmark these earnings for next year’s taxes if the memo is not made permanent by law. Most banks are still waiving withdrawal penalties, which is true of retirement accounts like an IRA or TSP through the remainder of the year.
- Increase retirement plan contributions on MyPay for the remainder of the year.
- Catch up on holiday accounts and get a head start on savings.
- Ramp up an emergency fund of 3- 6 months savings to relieve uncertainty of big ticket unexpected expenses.
- If you are planning to be in a lower income situation next year, move as much income from other sources as possible forward to 2021. Defer capital gains on those stock trades as necessary.
- Pay down as much debt as possible while interest rates are at record lows, especially consumer debt at double digit rates.
- Increase down payments on automobile and home purchases.
- Set a trend to pay more than the minimum payment on credit cards.
- Use the extra funds to join a big box store, like Costco or Sams, to pay the absolute lowest unit prices on merchandise. If already a member, buy a used freezer to put all the savings in.
There are a number of additional ways to use this four month deferral period wisely. It should not be looked at as a hassle or a trick to mess with your paycheck. Remember a dollar saved is a dollar earned, according to Ben Franklin. Because of inflation, a dollar today is worth more than a dollar tomorrow. Anybody shopping for meat recently can attest to that. In the end though, there are always two things certain in life: death and taxes so do not look at this opportunity as a GIFT but as a holiday goose. That is always better than the gander!
If you have any questions, give me a call in Family Readiness at 404-226-9478, Kevin Startt, PFC.