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A Basic Guide To Understanding Social Security Tax Limits

Did you know that the federal government sets a limit on the amount of taxable Social Security benefits? And although the Social Security tax rate has been the same since 1990, the number of your earnings subject to Social Security tax changes every year. 

This article discusses everything you need to know about social security tax limits, their history, and certain special considerations. 

Social Security Tax: What Is It?

Also known as the “Old-Age, Survivors and Disability Insurance Tax”(OASDI tax), the Social Security tax funds the Social Security program of the United States. 

The tax has two parts. The main one is categorized into two:

1. Payroll Tax

This is mandated by the Federal Insurance Contributions Act. It is based on an employee’s salaries, net wages, and tips. 

Typically, these taxes are withheld by the employer and paid to the government on the employee’s behalf. The Social Security tax rate is 6.2% for the employee and 6.2% for the employer. 

2. Self-Employment Tax

This is mandated by the Self-employment Contributions Act. If you’re self-employed, you’re required to pay Social Security taxes as part of the quarterly estimated taxes that you submit to the IRS. 

Since you’re self-employed, you’re responsible to pay for the full 12.4%, covering the employee and employer part. 

That said, the IRS allows self-employed individuals to deduct the employer’s share of self-employment taxes from their taxable income

Aside from these two, the other part of the Social Security tax is the Medicare or hospital insurance tax. Medicare taxes are split between the employee and the employer, with a 2.9% total tax rate.

How Does It Work?

The Social Security program pays a monthly benefit to retirees, disabled individuals, and surviving spouses and children. It comes from the tax that every working American pays. 

During your working years, the Social Security taxes that you pay are used to fund the Social Security benefits or income from existing beneficiaries. 

Once you retire or become eligible for Social Security benefits, current workers will pay into the program so that you can collect your benefits. The longer you wait to retire, the more Social Security income you receive. 

In November 2022, it was estimated that over 65 million Americans were receiving Social Security income of about $1,439 per month. According to the SSA, it is estimated that in 2022, about 70 million Americans will receive a bigger amount, about a 5.9% increase, of Social Security benefits. 

What Is The Social Security Tax Limit?

The Social Security tax limit refers to the maximum amount of earnings subject to Social Security tax. As mentioned before, the federal government changes this limit every year. 

The government base the yearly Social Security tax limits on changes in the National Wage Index, which usually increases every year. These changes are intended to keep Social Security incomes on track with the current inflation. 

For instance, due to the COVID-19 pandemic, the Social Security program is facing financing shortfalls that can potentially impact future benefits. So, by increasing the Social Security tax cap, the government can limit the shortfall. 

Last year, the Social Security tax was capped at US$142,800. In 2022, this limit is now US$147,000. Workers pay the 6.2% Social Security tax on their wages until they reach this tax cap for the year. And the maximum amount of Social Security tax withheld from an employee’s paycheck this year will be US$9,114 (US$147,000 x 6.2%). 

Once you reach the maximum taxable earnings, withholdings from your salary will discontinue and result in a higher paycheck. Any income you earn beyond the wage limit amount is not subject to the 6.2% Social Security payroll tax. It is also used to calculate future Social Security tax payments. 

Your company’s payroll department monitors this tax limit and will stop withholding for Social Security once you reach the limit. However, you want to make sure that the right amount was taken out at the end of the year. You don’t want to overpay because of multiple jobs or an employer error. 

In case of over-withholding, you can simply claim a refund from the IRS. 

Social Security Tax Limits History

The tax rate for Social Security payments rarely changes. As mentioned before, employees have been paying 6.2% for employed individuals and 12.4% for self-employed since 1990. 

Unlike the tax rate, however, the Social Security tax limit is adjusted every year. In the past 11 years, the federal government has increased the Social Security tax limit 10 times. And the largest increases were in 2020 (3.6%) and 2022 (3.7%). The increase this 2022 is lower than last year at 2.9%. 

Is There A Limit On Medicare Tax?

Although there’s a limit on the earnings subject to the Social Security tax, there’s no wage limit for your Medicare tax. All covered earnings are subject to the 1.45% Medicare tax that’s matched by employers. 

For instance, if you earned US$170,000 in 2022, the first US$147,000 will be subjected to the Social Security tax, but you’ll have to pay the 1.45% Medicare tax on the whole $170,000.

Furthermore, if you earn more than US$200,000 in a year, then, you need to pay an extra 0.9% on Medicare tax, which is not matched by your employer. 

The combination of the increase in your Social Security tax limit and the extra Medicare tax for high earners can lead to lower take-home pay. And workers who earned over US$200,000 in a year are at risk of owing more taxes this year. 

COLA Adjustments

Despite the increase in the Social Security tax limit, there’s also an increase in the amount of Social Security income. 

As mentioned before, the amount of Social Security benefits also increases every year. This is because of the yearly adjustment in Cost of Living (COLA), which is measured by the Department of Labor via the Consumer Price Index for Urban Wage Earners and Clerical Workers. 

This year, COLA will have a 5.9% increase, which is a big difference from the 1.3% increase for 2022. On average, beneficiaries will receive an average of US$1,657 in their Social Security benefits while couples can receive an average of US$2,753 in 2022. 

Conclusion

Social Security helps millions of disabled individuals, retirees, and surviving kids and spouses. The federal government adjusts tax limits every year in order to keep up with inflation, but it also means bigger payments for the recipients. 

That said, the annual increase may not be able to sustain your retirement alone. So, make sure to plan your future ahead and add more investment schemes that can near senior years.

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FinanceGABhttps://www.financegab.com/
Ajeet Sharma, the founder of Financegab and a well-known name in the field of financial blogging. Blogging since 2017, he has the expertise and excellent knowledge about personal finance. Financegab is all about personal finance which aims to create awareness among people about personal finance and help them to make smart, well-informed financial decisions.

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