The Social Security program is funded primarily by payroll taxes. That means the taxes that today's workers are paying will help fund current retirees' benefits, and once you start collecting Social Security, younger workers will be funding your monthly checks.
How much you'll pay in Social Security taxes depends on your income, but there are limits to how much you can owe. But the taxes don't stop once you begin claiming benefits -- in some cases, you may still owe taxes on your Social Security benefits even after you retire.
How much will you owe in taxes?
When it comes to taxes, most workers want to limit how much they pay. But in the case of Social Security taxes, the more taxes you pay, the more you can expect to receive in benefits later in life.
Your Social Security benefit amount is based on your income over the 35 highest-earning years of your career. The higher your income, the more you'll receive in benefits -- and the more Social Security taxes you'll pay each year.
However, once you reach a certain income limit, you'll no longer owe taxes on any earnings over that cap. For 2021, the maximum taxable earnings limit is $142,800. Anything you earn over that annual limit will not be subject to Social Security taxes. In addition, your future benefit amount will not increase once your income surpasses the maximum taxable earnings limit.
If you earn $142,800 per year in 2021, the maximum you'll pay in Social Security taxes is 6.2% of your income, or $8,853.60 per year. Your employer would contribute an additional $8,853.20 per year. If you are self-employed, you will pay double that amount (or $17,707.20 per year) because you would be responsible for both the employer and employee taxes.
How will taxes affect your benefits in retirement?
Although you'll no longer be subject to Social Security payroll taxes once you retire, you could owe income taxes on your benefits.
Your Social Security benefits are subject to both state and federal income taxes. Fortunately, only 13 states tax benefits, so depending on where you live you may already be in the clear. But federal taxes will depend on your income, and many retirees won't be able to avoid this type of tax.
To determine whether you'll owe federal taxes, you'll need to know your "provisional income." This number is half your annual benefit amount plus your adjusted gross income and any nontaxable interest. Keep in mind that Roth IRA withdrawals do not count toward your provisional income.
If you have a provisional income of $25,000 or more per year (or $32,000 or more per year for married couples filing jointly), you will owe federal income taxes on a portion of your benefits. The good news, though, is that regardless of your income, you won't owe federal taxes on more than 85% of your benefit amount.
Social Security taxes can be confusing. However, they can affect both your income during your working years and your retirement income. The more you understand how your income will affect your taxes during your career and in retirement, the easier it will be to prepare for your senior years.