My paycheck is a little fatter now. What’s the best use of that cash?

by Zack Sigel
My paycheck is a little fatter now. What’s the best use of that cash?

Last year, the Trump administration passed its signature tax overhaul law, the Tax Cuts and Jobs Act, which Republican legislators claimed would lower taxes for Americans across the whole income spectrum. The law makes a number of changes to the tax code, including repealing the tax penalty for forgoing health insurance, but many taxpayers won’t notice a huge difference in their tax filings immediately. One thing a lot of Americans did notice, however, was that they were starting to take home a fatter paycheck in early 2018.

Why did my paycheck change?

The U.S. has what’s called a progressive taxation system, in which people who earn less income pay a smaller percentage of taxes on their earnings, while those who earn more pay a larger percentage, determined by increasingly higher ranges of income known as tax brackets. The tax reform law made those percentages smaller across all tax brackets, meaning that regardless of what tax bracket you fall into, less taxes are being withheld from your paycheck.

Some people are reporting as much as $200 more in their paychecks. Others have had less fortune. A high-school secretary told the Associated Press that her extra $1.50 per week would cover her annual Costco membership — a paltry sum that Rep. Paul Ryan, the Republican speaker of the House, touted in a tweet he unsurprisingly deleted within hours.

What to do with those extra dollars

If you stand to gain from the new tax brackets, there’s a lot you can do with that extra cash. But the most important action you can take is to save it, because most of the tax brackets for middle-class workers are scheduled to sunset at the end of 2025.

In fact, the Institute on Taxation and Economic Policy estimates that by 2027, the bottom three-fifths of taxpayers will be paying higher taxes. The nonpartisan Congressional Budget Office’s analysis concurs, stating that, in 2019, the government will increase its revenue by an additional $80 from each person earning $30,000 a year, and $9,000 from each of those same people in 2020. (Those numbers are derived from a combination of tax increases and cuts to government services.)

You may also find that a lot of the deductions you took to lower your tax burden each year have been removed or reduced, due to some of the following changes:

  • The state and local taxes (SALT) deduction has been reduced to $10,000, when previously you could deduct the entire amount.
  • Deductions for mortgage and home equity loan interest payments have been reduced to the first $750,000 of mortgage debt and removed entirely from home equity loan debt. The deductions were previously the first $1 million in mortgage debt and the first $100,000 in home equity loan debt.
  • Deductions for personal casualty loss (destruction of your property from “unusual events”like hurricanes and earthquakes) and theft have been repealed, unless you suffer the lost in a federal disaster area.
  • Unreimbursed medical expense deductions have been reduced from 10% of adjusted gross income to 7.5%.
  • The personal exemption, which you could claim against your personal income for each dependent and your spouse if you file jointly, has been reduced from $4,050 to $0.

Almost all of the changes to deductions and credits won’t affect your 2017 tax returns, so you won’t get any insights into how much the new bill does — or doesn’t — save you annually when you file this year. With that in mind, here are some of your best options to protect your financial future:

1. Increase your 401(k) contributions

If your employer offers a 401(k) retirement plan, now’s the time to increase your contributions. A 401(k) works by automatically withdrawing a small percentage of your pre-tax income from your paycheck and investing it into an account with a high rate of return. Many plans start at 3% and you can choose to go higher. If you find extra cash in your paycheck, ask your employee-benefits administrator to adjust your contributions to 4% or 5% of your income. The more you contribute, the higher your returns will be each year.

2. Start an individual retirement account, like a Roth IRA

You should also consider opening an individual retirement account, if you haven’t already. You contribute to a Roth IRA with your after-tax income in return for withdrawing tax-free in retirement, which means that you’ll benefit financially if you’re in a lower tax bracket now than later in life. Roth IRAs also typically have lower expense ratios (the amount an investment charges to oversee your funds) than 401(k)s.

3. Pay off your student loans

Student loan debt is reaching a crisis: Americans owe an estimated $1.3 trillion in student loan debt, and that amount is only set to increase as colleges charge more and more for tuition. But the sooner you start paying it off, the less you’ll owe in the long run, because the unpaid balance accrues interest that will have to be paid off first. Some people are stuck paying off just the interest every year, barely making a dent in the balance. Use your fatter paycheck to increase your student loan payments. It could improve your credit score, and you’ll also save on future interest payments.

4. Take out a life insurance policy

Got kids? Got a spouse? Got bills? You’ll want to make sure your family is protected from the loss of your income if you die, so consider getting a life insurance policy. If you’re young and healthy, you may only pay a few hundred bucks a year for enough coverage to send your kids to college and pay off your mortgage. That’s a fair trade for peace of mind. You can’t deduct your life insurance premiums on your taxes, but your beneficiaries won’t have to pay any taxes on the death benefit.

5. Go on vacation

The changes to the tax brackets are scheduled to sunset at the end of 2025. That means you’ll be back to paying the same amount of taxes you paid in 2017. And, because of other changes to the tax code, such as the removal of common deductions, you might be paying higher taxes when you file your return. If your savings look healthy, consider using the extra cash to treat yourself to a vacation. You’ve earned it.

6. Save for a home – it’s a great long-term investment

While the extra cash in your paycheck might not be more than a few hundred bucks at a time, it could help you save for a down payment on a house. For many people, a home is their most important financial asset and could pay off mightily in the long term. Speaking of investments...

7. Avoid cryptocurrency

At the end of 2017, the price of bitcoin skyrocketed to an eye-watering $18,000 per bitcoin. A lot of people who’d bought earlier that year, when a bitcoin cost a mere $1,000, suddenly found themselves very wealthy and some even bought houses or made other expensive investments. That said, cryptocurrency is not really the best use of your extra cash. Since the beginning of 2018, bitcoin has lost about 50% of its value, with no end in sight, a volatility that could only have been predicted by… literally the entire history of bitcoin pricing economics. A lot of people learned the hard way that the purpose of currency isn’t to hold onto it in the hopes of receiving an astronomical rate of return, but to actively spend the currency in the market.

Image: RyanJLane