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How will you spend raise from Uncle Sam?; Tax-cut extension means larger check

In the old days, a 2 percent boost in pay wouldn't sound like much. But for the folks who haven't had a raise in a year or two -- or who had to face a continuing diet of furloughs and pay cuts during the Great Recession and its aftermath -- it sounds positively glorious.

In the new legislation that temporarily extends the Bush-era tax cuts, U.S. workers will pay 2 percent less in Social Security taxes this year. For someone who earns $50,000 a year, that's a tax savings of $1,000. The refund is capped at $2,136 for those who earn $106,800 a year.

However, the money won't come in one lump like a federal income tax refund or a traditional tax rebate. Instead it will show up in each paycheck this year, a design that encourages consumers to spend a little more freely to give the economy a boost.

While that sounds good -- after all, who doesn't like a few extra dollars in their pocket each payday? -- it's also easy to let the extra money slip through your fingers.

So financial experts recommend devising a plan before the first dime comes in by either adding the extra cash to a retirement account, using it to pay down debts or beefing up cash reserves.

And make the withdrawal automatic so there's no chance the extra money will be spent before it's squirreled away.

"If you don't plan for it, it will be spent on frivolous things like going out to eat and buying music, and you won't have anything to show for it at the end of the year," said Houston-based financial consultant Paul Lebouef from Charles Schwab & Co.

He plans to use the tax holiday to beef up his own cash reserves because he has already maxed out the contribution limits for his retirement accounts. The money will automatically go into his savings account.

"If you work for a company that has a 401(k) and you haven't signed up yet, now is the time," said Andrew Gardener, a certified financial planner at Tanglewood Legacy Advisors and the chairman of the Financial Planning Association of Houston.

If you already have one and you haven't hit the contribution limit, here is your chance, said Gardener, who counsels individuals about their finances. The payroll deduction for a 401(k) account has another advantage: the money goes in pre-tax and grows tax free until it's withdrawn, which increases the overall savings.

Tara Hays, an operations accountant for an oil and gas company in Houston, said she will use her 2 percent tax cut to build up her 401(k) account. Like other workers who were surveyed about their plans for the extra tax savings, Hays said she wasn't aware of the one-year Social Security tax holiday.

"That's good news," said Hays, who added that when she got back to her office after a lunchtime walk she would immediately bump up her 401(k) contribution. That way the money would begin coming out from her paycheck after the first of the year.

If that option doesn't appeal, another good use of the tax holiday would be to spend the money paying down your revolving high interest debt like credit cards.

Set it up as an automatic payment and send the extra money to the card with the lowest balance, recommends Lebouef. Paying off one credit card not only offers a psychological boost, he said, but then you can send twice as much money to pay off your next highest balance.

Other options include putting the money toward your children's college fund or using it to supplement emergency cash reserve funds.

That way you have money if you lose your job, your air conditioner breaks down during the summer or you face some other household disaster, said Edward M. Gardner, a certified public accountant and certified financial planner in Houston who consults with individuals and business owners. Everyone should have three to six months of living expenses stashed away, he said.

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