Retirees rely on Social Security for a large portion of their retirement income, and even those who make six-figure incomes expect to get a sizable payback for the payroll taxes they've paid into the Social Security system. If you earn $125,000 a year, then you make more than five out of every six American households, and unless you live in a particularly high-cost area of the country, you'll have ample financial resources to save money toward building up a retirement nest egg. Nevertheless, it's important to know what role Social Security will play when you retire. Below, we'll take a look at how much someone earning $125,000 per year can expect to receive from Social Security.
Why you can expect a big payroll tax hike
If you earn $125,000 per year, then you'll be seeing a big change in Social Security next year. For 2016, the wage base limit on Social Security is $118,500, meaning that those who earn more than that stop having to pay additional payroll taxes on the income above the threshold. That translates to maximum taxes of $7,347, or 6.2% of $118,500 (and your employer also pays $7,347 on your behalf). Because of the cap on taxable income, you would be treated as earning $118,500, rather than $125,000, for the purpose of determining your total benefit.
However, for 2017, the wage base limit jumps all the way to $127,200. That means that your entire $125,000 salary will be taxed for Social Security purposes. The payroll tax rate of 6.2% works out to $7,750 for the employee portion of payroll taxes, which is a sizable jump. The silver lining is that your entire $125,000 salary will get counted toward your earnings history for benefit calculation purposes.
As with other income levels, even if your salary is $125,000 in a given year, your Social Security benefit may not be based on that pay level. Social Security looks at your entire career, picking the 35 best-paying years (after adjusting for inflation) and then taking the average monthly earnings as a starting point for applying the benefit formula to determine your monthly payment.
This means that if you've consistently earned a high salary, then you'll have average earnings that are close to your current earnings level. However, if you've risen quickly through the ranks, then you'll have to sustain your upward trajectory in order to produce an average earnings amount that matches up with what you're getting paid right now. A single year's earnings won't have the same influence that they might on a government or private pension.
Your Social Security benefits
To come up with a monthly payment estimate, you have to make assumptions. We'll look at people who turn 62 next year, have already worked for 35 years, and have gotten raises over the course of their careers that match up with the rate of wage-base inflation. That will make the necessary calculations much simpler. You can adjust the results to match up better with your particular earnings history.
Our hypothetical scenario would produce average indexed monthly earnings of $10,417 per month. To calculate your benefits, since you'll be age 62 in 2017, start with 90% of the first $885 in monthly earnings, and then add in 32% of earnings between $885 and $5,336, along with 15% of earnings above $5,336. Here's what the math looks like:
- 90% of the first $885 = 0.9 x $885 = $796.50
- 32% of earnings between $885 and $5,336 = 0.32 x $4,451 = $1,424.32
- 15% of the remaining $5,081 = 0.15 x $5,081 = $762.15.
- $796.50 + $1,424.32 + $762.15 = $2,982.97
In short, your primary benefit amount is $2,982.97 per month. That's what you'll receive if you wait until your full retirement age, which for someone born in 1955 will be 66 years and two months.
You can see that Social Security represents only a small portion of a high-income worker's pay. Those making $125,000 a year will get less than 30% of their pre-retirement income replaced by Social Security. That's a far lower percentage than those with lower average earnings receive, making it clear that those who want to sustain their standards of living will need to save independently to supplement their Social Security benefits.
If you retire earlier or later than your full retirement age, then your monthly check will be different. If you claim at age 62 -- your first opportunity to do so -- then the benefit reduction of nearly 26% will leave you with about $2,262 per month. If you don't claim until you turn 70, then you'll get almost 31% more, with monthly benefits of almost $3,900.
Finally, everyone should recognize the impact that working only part of a career has on their Social Security benefits. For example, say you earned $125,000 for only 17 or 18 years, rather than 35. You'll have paid half the Social Security payroll taxes of a full-career worker and worked half as hard, but you'll get more than half of the benefits of a full-career worker. When you do the math, the benefits for average monthly earnings of $5,208 work out to $2,179.86, or 73% of a full-career worker's benefits. Getting paid nearly three-quarters of what you would have gotten isn't bad for someone who chooses to retire early or take long breaks from their career.
Get what you need to retire rich
For high-income workers, Social Security adds a significant chunk of income to your retirement finances, but it won't be enough to finance a retirement that looks like how you lived before you stopped working. By diverting some of those earnings toward retirement savings, you can make up the difference and live the retirement of your dreams.