With the Presidential "Payroll Tax Holiday" being imposed, should I invest the money in ROTH IRA or Regular Brokerage?

Question

We've had a Presidential order creating a "payroll tax holiday", and the best information I can find about this can be read at Forbes and summarized as follows:

• No/Reduced federal tax from July 1 until December 31, 2020
• Taxes are deferred, not cancelled or suspended
• Taxes will eventually be owed later

It's this last line-item that gives me pause, and so when I get a larger than usual/expected paycheck, I plan to throw it in an S&P 500 fund and let it grow quietly until the IRS comes calling asking for their money, then I can keep the gains on it and they can have the principal back. So far, so good.

Here's where things get interesting. I know I can contribute up to 6K to a ROTH IRA per year. I am Nowhere Near the limit, sitting around ~$400 in my ROTH IRA right now for the year. I know I can pull out my principal contribution to my ROTH IRA at any time without penalty. Therefore, I have two options. I can either:

1. Store the tax funds in a conventional taxable brokerage fund

or

2. Store the tax funds in a tax advantaged ROTH IRA brokerage fund

Either way, I'll have the IRS' money set aside for when they want it, but what makes more sense? How is this 'untaxed money set aside to pay taxes' best handled in this case? I can't even begin to comprehend how the law will play out here, or how the tax code treats this money.

The only things I can see for sure is that if I throw it in the IRA, the growth can continue to grow tax advantaged, if I keep it OUT of the IRA, I can throw it into my 'buy a house' fund afterward, and if the S&P 500 takes another brief dip around the time the taxman comes a'callin', I will have to make up the difference out of pocket.

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The main article I am referencing is this Forbes article. which confirms an executive order is announced. The section under the heading "Payroll Tax Holiday" explains the effective power of President to effect a payroll tax holiday.. Article states: "Cutting taxes would require Congressional action, but Trump could use his emergency powers to delay collecting taxes—meaning they would theoretically have to be paid back later unless Congress agreed to waive repayment."

Answer 1

(Note: This answer has been rewritten.)

Trump has signed this executive order today, August 8, 2020. As expected, the details are different from what was previously announced and reported.

Before I get to the actual answer to your question, I want to correct some of the assumptions in the question. Your three point summary of the implications of this order are not correct.

1. This action affects the Payroll Tax (FICA), not the federal income tax. And according to the text of the order, it takes effect September 1 - December 31, 2020.

2. The tax is deferred, which apparently means it is not to be withheld from your paycheck. This deferral only affects paychecks that are less than $4000 in a 2 week period (or the equivalent amount of pay for different periods). If you earn more than that, there is no deferral.

3. It is unclear if this money will ever need to be paid back. The executive order states: "The Secretary of the Treasury shall explore avenues, including legislation, to eliminate the obligation to pay the taxes deferred pursuant to the implementation of this memorandum."

It is not predictable how the politics will play out eventually. As I said in the first draft of this answer, requiring a payback of back FICA taxes would be unprecedented and problematic, to say the least, but anything is possible. In addition, you can expect lawsuits to happen before this order takes effect.

Because of this, it is sort of pointless to try to figure out the best course of action when things are still so much up in the air.

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All that having been said, let's generalize this and answer your question making the assumption that you have some extra money, and you expect to have to pay it back within a year.

Given that, putting it in the stock market in any fashion is a mistake. An S&P 500 index fund is a great long-term investment, but if you expect to need to pay back this money within the next 6-12 months, the stock market is too risky. If you want to park this money, it needs to be in something very safe: a bank account or money market fund.

A Roth IRA would be pointless for this. It won't save you any tax when you put the money in, and when you withdraw it, you won't be getting any tax-exempt earnings from it, either. The only tax benefit you would have would be not paying tax on the tiny amount of interest you would earn on this money before you take it out and pay it back.

Answer 2

The deferral of payroll tax doesn't affect income tax. Even if you have to pay back the deferred payroll tax next year, that is calculated separately from income tax, and doesn't affect your tax rate next year.

From your question, it seems you are asking generally about if you have some extra money now that you expect to have to spend later (not necessarily from deferral of payroll tax; it could be also from underwithholding early in the year and withholding more later in the year, or any other situation in which you temporarily have some extra money), whether to put it in a taxable account or a Roth IRA.

If you didn't plan to put money in any IRAs (Traditional or Roth) anyway, and you qualify to make contributions to Roth IRA, then you are correct that putting the money that you were going to put in a taxable account into Roth IRA (and investing it the same way you were going to in the taxable account) can't hurt, because you can withdraw contributions to Roth IRA at any time without tax or penalty, and in the short term, most of the money will be contributions.