Tax reform windfall: suggestions for the extra $ in your paycheck!

The Tax Cuts and Jobs Act has lowered income tax rates across nearly all tax brackets, and this lower tax withholding translates to slightly bigger paychecks for most folks. For some people, the increase in take-home pay has already gone into effect. Still others may have to wait until next month to see a difference in their paystub. Nevertheless, economists and consumer analysts have been busy since before the bill was signed into law speculating as to what workers will do with this windfall, estimated to be worth approximately $264 billion over the next two years.

Whether the auto industry or electronics manufacturers will see an uptick in sales as a result of the tax reform, only time will tell. Here’s what we do know. Consumer debt is at an all-time high. Back in November, The Federal Reserve Bank of New York reported that “household debt totaled $13 trillion in the third quarter… an increase of 0.9% from the previous quarter” (Source: Credit card and auto loan balances are increasing, and auto loan delinquencies are also on the rise. Student loan debt is another major area of concern: it’s the second highest consumer debt category—higher than both credit cards and auto loans. In 2017, the default rate on student loan debt was 11.2%. Yikes.

Of course we’re not suggesting that there’s anything intrinsically wrong with using the extra “dosh” to buy a TV (or an ATV,) but with consumer debt and the cost of education on the rise, perhaps there are other ways to use this unexpected bonus.

  1. Pay down debt. We know, we know this isn’t the “fun” option. (We're financial advisors-- what'd ya expect?!) But consider the impact an additional $50 per paycheck could have on a credit card balance of $5000 at 15% interest. Payments of $350 per month versus $250 would reduce interest paid and lower the payoff date from 24 months to 16 months.
  2. Beef up your savings and/or emergency fund. An emergency fund is a readily available source of liquid assets, sufficient to pay 3-6 months of fixed and variable expenses. A 2017 survey found that 57% of Americans have less than $1,000 in their savings accounts. An unexpected emergency can wreak financial havoc if the only option is to use a credit card. (See point #1)
  3. Increase your 401(k) contribution. If you aren’t contributing or aren’t contributing enough to get the full match, consider increasing your deferral rate. Contributing an additional $25 or $50 per pay period may not seem significant, but over time it can really make a difference! Remember, “compound interest is the eighth wonder of the world.”
  4. Save for education expenses. If you have young children, consider putting some money into a 529 Plan. 529 College Savings Plans are tax-advantaged investment vehicles which help fund a child’s future education needs. The average cost of in-state tuition is around $25,000 for a four year degree program. Assume an account was started in the year of the child’s birth: with prudent investing and moderate inflation, contributions of about $100.00 per month through an 18 year period would likely cover tuition costs!

Of course, it’s difficult to know exactly how the tax reform will affect your overall tax position until next year, but no time like the present to pay down some debt or invest for the future! (Then talk about buying the ATV.)

Questions? Call us!