The Payroll Tax Hike Hurts You More Than You Realize

1040You are probably aware by now that the fiscal cliff deal raised your taxes by 2% if you are currently working. Neither party, in their near-pointless fight over high income tax rates, bothered to address this tax hike on 77% of Americans. The main reason for the apathy towards this tax increase is the fact that the payroll tax provides about 40% of the revenue the Federal government takes in.

While the government does need to be funded, working class individuals, particularly younger workers, are getting screwed by this tax increase. Time gives us the rundown:

Doubtless, many workers will cut their savings in order to maintain their lifestyle. Here’s what that looks like, according to a report in the Wall Street Journal:

A 30-year-old making $50,000 will see his take-home pay shrink $1,000 this year. If instead of cutting spending this worker puts $1,000 less into his 401(k) this year, he could have nearly $12,000 less by retirement at age 66. If he doesn’t increase his savings rate over the next 36 years, the loss to his retirement account could approach $236,000. (And this isn’t even considering any employer matching contributions.)

Looking at it another way, consider two 25-year-olds who start saving 10 years apart — one immediately and the other at age 35. Mutual-fund firm Vanguard calculates that if the early saver stashes away $2,000 a year until age 35 and then saves nothing more, she will accumulate $314,870 by age 65 (based on 8% average annual returns). If the late saver stashes away $2,000 a year for the rest of her working life, she will have just $242,692 at age 65 despite having invested three times as much money.

That’s the power of compounding, and it points up what may be the biggest cause for concern if young people choose to offset this year’s payroll-tax increase with reduced saving as opposed to reduced spending.

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