Make the Most of Your Payroll Tax Holiday

Last Updated Jan 3, 2011 6:21 PM EST

This year employees get to pocket more of their salary, thanks to the payroll tax holiday -- part of the tax deal signed in December -- which will reduce workers' social security taxes this year from 6.2% to 4.2 %.

Let's say you earn $75,000 a year. That means you can expect to receive $1,500 back this year. What to do? While the government would like us to spend this money on iPads, vacations and dinners out to boost the economy, I've got some other ideas on how to make this 2% go further and improve your personal finances. (Fellow MoneyWatch blogger Carla Fried offers some great patriotic solutions, too.)

1. Chip Away Your Student Loan Principal.

Young adults struggling with their student loans can easily reduce their monthly payments and minimize interest payments by putting a little extra toward the principal of the loan. Let's say your debt load totals $20,000 with an interest rate of 7%. Spread over 10 years, you're looking at a monthly payment of $232, according to Sallie Mae's college loan repayment calculator. If you bring down that principal to $18,500 and continue to pay the minimum $232 a month in payments, you'll save $1,400 in interest over the life of the loan. (See more of my tips on reducing student loan debt.)

2. Increase Monthly Payments Towards Credit Card Debt.

If you're stuck only making minimum payments on your credit card, consider this tax holiday your personal debt-onator. Each month, based again on hypothetical earnings of $75,000 a year, you can expect an extra $125 back in your monthly paycheck. Imagine how fast that could help shrink your credit card debt. Let's do some math: Say you owe $5,000 on your Visa. The interest rate is 15%, the national average, making the monthly minimum $112.50 (equal to interest plus 1% of your balance). But if you tacked on an extra $125 to that minimum and made fixed payments of $237.50 each month, by the end of the year you'd have chopped $2,250 off that balance -- four times more than had you just paid the minimum $112.50 a month.

3. Invest in Yourself.

With $1,500 you can take big steps toward self-development and maybe even getting a leg up in the job market. From hiring a freelance techie to design you a personal blog to taking a course at a local community college and joining a networking club, there are many ways to turn this tax holiday into a gift that keeps on giving. And as we've learned, one of the keys to happiness is spending money on experiences, as opposed to things.

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Photo courtesy: MeddyGarnet's photostream on Flickr


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    Farnoosh Torabi is a personal finance journalist and commentator. She is the author of the new book Psych Yourself Rich, Get the Mindset and Discipline You Need to Build Your Financial Life. Follow her at www.farnoosh.tv and on Twitter at @farnoosh.