Some changes are coming to Social Security next year, and one of them could mean more money comes out of your pocket. While the vast majority of earners will not be affected by this change, some Americans will end up owing more Social Security tax in 2021 than they did in 2020. In fact, the added tax bill could total as high as $632. Here's why.
Social Security taxes are going up, but not everyone will be affected
To understand why Social Security taxes are going up for some Americans, you have to understand how these taxes work. Social Security is funded by a payroll tax, which is collected on income you earn. But it's not collected on all wages for every American. Instead, there is a wage base limit. You'll pay payroll taxes on all income you earn up to the limit, but no further Social Security tax on any money you earn once you exceed it.
In 2020, the Social Security wage base limit was $137,700. In 2021, however, it's going up to $142,800. That change means Americans with incomes above $137,700 will owe Social Security taxes on up to $5,100 more of their wages if they make $142,800 or more. And anyone who makes above $137,700 will owe something extra too, even if they don't make the full $142,800.
Payroll taxes add up to 12.4% of wages total, but employees don't pay the entire amount directly -- it's split between employers and employees who each pay 6.2%. Self-employed workers, on the other hand, do pay the full 12.4% tax on their wages. That means for self-employed Americans who earn at least $142,800, they'll owe an extra $632.40 in taxes. And for those whose income exceeds this threshold but whose employer covers half their tax, they'll owe $316.20 extra over the year.
The good news is, while a larger tax bill can be a bummer, there's a bright side. Your Social Security benefit is determined based on your average wages over the course of your career, but only income up to the wage base limit counts. When the wage base limit is higher and you pay more in Social Security taxes, you get credit for this extra money, and your monthly benefits will be higher later because of it.
Be prepared to see money come out of more of your paychecks
In most cases, employers withhold payroll taxes from workers, so the added taxes that higher earners will owe will just be subtracted from their paychecks before they receive them. When wages hit the limit for the year, the withholding stops. Self-employed workers, on the other hand, will generally pay the added tax as part of their quarterly estimated tax payments.
While this isn't a lot of extra money when it's paid over the course of a full year, it does mean that your paychecks may take a hit for a little bit longer in 2021 if you're one of the millions of Americans whose income tops $137,700. Be sure to plan for that when you're making next year's budget.