On an intermittent basis, the Social Security Administration (SSA) announces a key number that affects the take-home pay of entrepreneurs and employees alike; namely, the Social Security taxable wage base. The wage base – the maximum dollar amount of a person's earnings that's subject to the Social Security tax – rises in response to an increase in overall wage levels. For instance, while the wage base was $25,900 in 1980, in 2021 it will be $142,800.
Before you get your first 2021 paycheck, it might be worthwhile to consider the effect of this change in the Social Security wage base on your take-home pay.
Understanding FICA Taxes
The Federal Insurance Contributions Act (FICA) states that Social Security and Medicare taxes are to be withheld from a company’s payroll and from the income of the self- employed. In 2021, the Social Security tax will account for 6.2 percent of an employee’s earned income up to the annual limit that’s dictated by the SSA according to wage growth. In turn, Medicare taxes amount to 1.45 percent of earned income.
Your employer pays those same amounts on your behalf, which means the total FICA tax that your employer submits to the federal government is equal to the sum of 12.4 percent and 2.9 percent of your salary, or 15.3 percent. In contrast, if you’re self-employed, you pay the entire amount; that is, 12.4 percent for Social Security taxes and 2.9 percent for Medicare taxes.
Read More: What Are FICA Wages?
Taxable Wage Base
The maximum earnings that are subject to the Social Security tax – the taxable wage base – will increase 3.7 percent from $137,700 in 2020 to $142,800 in 2021. According to the latest SSA Population Profile of Taxable Maximum Earners, the wage base increase affects about 6 percent of covered workers, which in 2019 numbered about 178 million. Neither you nor your employer are required to pay a Social Security tax on earnings above the maximum taxable amount.
But the increase may be a shock to the self-employed who must pay the maximum Social Security tax per employee in 2021, which is 12.4 percent of $142,800, or $17,707.20. The wage base increase may also surprise the highly-paid employee and their employer, each of whom must pay the maximum tax per employee of 6.2 percent of $142,800, or $8,853.60.
Read More: Maximum Social Security Retirement Benefits
Social Security Benefits
The wage base also limits the wages that the SSA considers when calculating the amount of your Social Security benefit. The benefit amount is determined by a formula that includes your average earnings during a 35-year period during which you achieved your peak earnings. For any year that you earned more than the wage base, those wages are capped by that year's wage base.
Just as you didn't pay tax on earnings that exceeded the wage base, the earnings that are considered in your benefit calculation are capped by the wage base. For example, if your salary in 2021 is $95,000, that entire amount will be considered when the SSA calculates your average earnings. If, however, you earned $205,000 in 2021, the SSA will consider only $142,800 of your earnings.
The wage base influences both the Social Security taxes you pay and the dollar value of your Social Security benefits when you retire. The amount you pay is determined by that portion of your salary that is less than or equal to the wage base. Likewise, the SSA benefit you receive is determined by the highest salaries you earned during a 35-year period, each of which is capped by the relevant year's wage base.
- Social Security Administration: Contribution And Benefit Base
- Social Security Administration: 2020 Social Security Changes Fact Sheet
- Social Security Administration: Contribution and Benefit Base
- Social Security Administration: Fact Sheet Social Security
- Social Security Administration: Population Profile: Taxable Maximum Earners
- Social Security Administration: Social Security Benefit Calculation Examples for Workers Retiring in 2021
- Internal Revenue Service. "Topic No. 751 Social Security and Medicare Withholding Rates." Accessed Jan. 14, 2020.
- American Payroll Association. "State Unemployment Insurance Taxable Wage Bases 2017-2020." Accessed Jan. 14, 2020.
Billie Nordmeyer is an IT consultant of 25 years standing. As a senior technical consultant for SAP America and Deloitte Touche DRT Systems, a business analyst, senior staff, and independent consultant, Billie has worked across the retail, oil and gas, pharmaceutical, aeronautics and banking industries. Billie holds a BSBA accounting, MBA finance, MA international management as well as the Business Analyst and Software Project Management certificates from the Cockrell School of Engineering at the University of Texas at Austin.