Election season is upon us and there is one point of conversation that comes up again and again: taxes. Regardless of where you fall on the political spectrum, understanding the basics of taxation is a must for personal financial decision making as well as serving as an informed citizen.
Most workers received their first paycheck when they were in a wage-based position likely in high school or college. Social security tax is sometimes annotated as OASDI (Old Age, Survivors and Disability Income) or as FICA (Federal Income Contributions Act) that also includes Medicare. Here are a few facts about social security tax to help you better understand what and how you pay.
First, social security is only assessed on earned income, that is compensation earned from providing a service or labor. It’s not assessed on investment income, inheritances or pensions. Military members avoid social security tax on their allowances for housing, subsistence, and others. The tax rate for social security is 6.2% paid by the employee and 6.2% paid by the employer. Self-employed individuals bear the full burden of 12.4% social security tax and should be careful to submit quarterly estimated payments to avoid penalties.
Higher income earners may be above what is known as the 'social security wage base.' Employees essentially stop paying social security tax once their individual income reaches the wage base in a single calendar year. The wage base is $168,600 in 2024 and those employees whose compensation exceeds this amount will notice an increase in take-home pay partway through the year. I encourage these employees to have a plan for their increase in net income that involves more than an expenditure!
For example, an employee who earns $230,000/year in equal semi-monthly paychecks will reach the wage base in their seventeenth pay period. The employee has paid their mandatory $10,453 of social security tax for 2024 and their October-December payments will each be $594 larger. The additional $594 received for the remaining six pay periods equals $3,564 and is useful for funding a number of goals, often a Backdoor Roth IRA. Another favorite strategy is to use the funds for a child’s 529 education account. A significant portion of a child’s post-secondary education can be funded by simply having an intentional plan in place after the annual social security wage base is reached!
If an individual has multiple jobs that results in overpayment of social security tax, they should request a refund or use it as a credit against income tax when filing their tax return. They may also ask their employer(s) to stop withholding social security tax. Multiple employers may be the result of a job change mid-year, moonlighting or supplemental self-employment income.
Social security payments received in retirement (or under other circumstances such as disability) are calculated based on the income subject to social security tax. The highest 35 income earning years set the basis for the primary insurance amount, which may increase or decrease based on the claiming strategy used by the retiree. A social security benefits statement is available online at https://www.ssa.gov. I urge you to create your account and login to begin understanding your social security records.
Employee 401(k), 403(b), or IRA retirement plan contributions do not avoid the 6.2% social security tax, although they may sidestep state and federal income taxes depending on the traditional or Roth tax designation. As a result, employee contributions to retirement plans do not directly reduce the amount of social security benefits received later in life.
The policy conversations about social security are likely to heat up in the coming years. I hope this overview of how and what you pay in social security tax helps you better understand your paycheck, retirement and financial planning opportunities!
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