The Social Security Administration, or SSA, recently announced its inflation-related changes to the program for 2019. One of those changes is the amount of earned income that could be subject to Social Security tax, and the short version is that higher-earning American workers could see a significant Social Security payroll tax hike.
With that in mind, here's a quick overview of how the Social Security tax works, how much income will be taxable for Social Security in 2019, and what it could mean to your eventual Social Security benefits.
How does the Social Security payroll tax work?
The taxes American workers pay to fund the Social Security and Medicare programs are collectively known as FICA taxes and are often simply referred to as the payroll tax.
The Social Security portion of the payroll tax is known as OASDI (Old Age, Survivors, and Disability Insurance) and is assessed at a rate of 6.2% each for employees and employers. The Medicare portion is an additional 1.45% tax. As with the Social Security tax, employees and employers each pay the Medicare tax as well.
While the Medicare tax is assessed on all earned income, there's an annual limit to the amount of earnings that are subject to Social Security tax. And it's important to stress that only earned income is considered -- meaning income from a job or a business you actively participate in. Passive sources of income, such as interest, dividends, or capital gains, are not taxed for Social Security purposes.
The maximum Social Security tax for employees will be $279 higher
For 2019, the maximum taxable earnings for Social Security is rising to $132,900 from the 2018 limit of $128,400. In other words, if you earn $132,900 or more, an additional $4,500 of your income will be taxed for Social Security.
Based on the 6.2% Social Security tax rate, this means that your Social Security tax could be $279 greater next year if you're a high earner.
Going a step further, the payroll tax for 2019 will be assessed as follows:
- 65% on the first $132,900 of earned income (6.2% for Social Security and 1.45% for Medicare).
- 45% on any earned income in excess of $132,900 (Medicare only).
For self-employed individuals, the increase could be doubled
If you're self-employed and earn more than 2019's taxable maximum, your Social Security tax increase could be twice as much.
Self-employed individuals are considered to be both the employer and the employee for payroll tax purposes, so they have to pay both sides of the tax. For Social Security tax alone, this means that high-earning self-employed individuals could pay as much as $16,479.60 in 2019 -- $558 more than the maximum Social Security tax for the self-employed in 2018.
But your eventual benefits could be higher as well
The other side to the Social Security taxable maximum earnings increasing is that the maximum Social Security benefit will be higher as well. You can read a thorough discussion of the Social Security benefits formula if you're interested, but the key point is that the benefit you initially receive is based on your 35 highest-earning years up to each year's taxable maximum -- adjusted for inflation.
So as inflation occurs and the taxable maximum increases over time, the Social Security benefit that lifetime high earners can receive increases as well. In fact, the maximum possible Social Security benefit for a worker retiring at their full retirement age in 2019 will be $2,861 per month -- $73 more than in 2018. In other words, although your payroll taxes are increasing in the meantime, your eventual Social Security benefit could be higher as a result.