Understand the Federal Tax Deferral before it’s too Late

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If you are a federal employee or member of the military, the 6.2% social security tax withholding on your regular paycheck is currently on a mandatory deferral until January 2021 if your taxable wages are below a certain threshold; $4,000 per pay period for federal employees and $8,666.66 per month for military service members. Employees will need to repay these taxes from January through April 2021 (or earlier if you separate or retire from service before April 2021). Additionally, non-federal organizations can elect to follow along with this deferral plan.  The intent of this deferral is to put more money in people’s pockets to provide financial relief during the COVID-19 pandemic.  While financial relief sounds wonderful, it is important for those employees impacted to understand the long-term implications.

While the individuals receiving this payroll tax deferment have paying jobs at the moment, it doesn’t mean that they are not financially burdened by the COVID-19 pandemic.  Perhaps you were part of a two-income household and your spouse has been laid off. Maybe you split rent with roommates who are struggling to pay their bills since COVID started. Even if you have not been financially impacted by the pandemic, there are still consequences of this tax deferral that you need to plan for.

Spend Only What You Need

It is imperative that you remember that this is only a temporary deferral which means none of the money should be spent on “wants”.  “Wants” are items that you purchase for entertainment and that are not necessary to maintaining financial health. Typically, an increase in purchasing “wants” comes when your income sufficiently exceeds your fixed and periodic expenses.  We call this excess “discretionary income.”  The excess money you receive in these next four months should only be used on necessary expenses to maintain a healthy financial lifestyle.

  • Housing – If the pandemic has you struggling to make your mortgage or rent payments, the first thing this extra money should be allocated to is this category. Keeping a roof over your head should be your number one priority.
  • Food/Clothing – Keeping yourself and your family fed and clothed is your next priority. This does not mean that the extra money in your pay check should go towards eating out or impulse clothing purchases on Amazon.  This means you are prudently grocery shopping to ensure your family can put meals on the table and that everyone has adequate, seasonal clothing to keep themselves healthy.
  • Debt – Once housing and necessary food and clothing are taken care of, keeping up with minimum payments on your debts should be your next priority. If you are in a financial crisis, now is not the time to pay more than your minimum payments, but by paying the minimum due, you will help keep your credit score in good standing.

Move What you Don’t Need to Savings

After you have taken care of your necessities, put the remainder immediately into a savings account.  This will prevent you from spending more than you need and will help you keep a cushion available for when the deferral period ends.

Adjust Your Budget Again Come January (until April 2021)

While this tax deferral will increase your net pay from September until December, under current guidance, taxes will resume in January 2021.  From January through April 2021, not only will you have the regular social security tax withheld from your paycheck, but you will also start to pay back the taxes that had been deferred.  This means your net pay from January through April will be approximately 12% less than your paychecks in September through December and 6% less than the paychecks you had been receiving prior to September 2020.  You must build these fluctuations into your budget to avoid falling short for your expenses.

While deferment on your financial obligations can be exciting, it is imperative that those receiving this financial relief remember that it is only temporary.  It’s important to know the rules and regulations around the deferral but it is even more important to understand how to handle the increased income and how to plan for paying back the deferred taxes.  If you are struggling with your budget, or do not currently have one, call us today.  We can help you get a better handle on your different types of expenses, learn the most effective way to handle your income and prepare for a financial crisis.