Retirees who are claiming Social Security benefits got some good news this year when the Social Security Administration (SSA) announced that benefits will rise by 8.7% in 2023, thanks to the SSA's annual cost-of-living adjustment.
The increase will help retirees deal with some of the highest inflation in more than 40 years, which has significantly increased the cost of living.
But the SSA also announced other changes to the Social Security program, including those that more broadly affect workers in all age groups. One of those changes has to do with Social Security taxes and is likely to result in these taxes skyrocketing for high-income earners in 2023. Here's why.
A growing wage base
You may have noticed in your paychecks that you have to pay a Social Security tax, which is how the program is funded. The idea is that you contribute to the program now so you can receive benefits when you are older. The tax rate for Social Security is 6.2% both for employees and employers, but if you are self-employed, you end up paying the entire 12.4% total yourself.
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Each year, the SSA sets the maximum amount of earnings that workers have to pay Social Security taxes on, a number that is referred to as the benefit base or wage base. This base is derived from a formula each year. While the formula can get pretty complex, it is heavily based on the national average wage index (NAWI) in the two years prior to the year for which you are trying to calculate the new wage base. So if you are trying to calculate the new wage base for 2023, you are basing the formula on the NAWI in 2021.
According to the SSA, you can calculate the NAWI for 2021 by taking the NAWI in 2020 and multiplying it by the change in wages between 2020 and 2021, which comes from data calculated by the SSA. The NAWI for 2021 came out to $60,575.07, which is up roughly 8.89% from the NAWI in 2020 of $55,628.60.
Then this amount is plugged into another complex formula to calculate the final wage base for 2023, which came out to $160,200, up from $147,000 this year. That's the largest increase to the wage base in quite some time, which makes sense when you think about inflation being at a 40-year high and there also being a significant amount of wage inflation.
Your taxes could jump
With the new wage base at $160,200, high-income earners will pay a 6.2% Social Security tax on that amount if they are employed or 12.4% if they are self-employed.
So if you are self-employed and plan to make $160,200 next year, your Social Security tax bill will be roughly $9,932, which is $818 more than what you paid this year with the wage base at $147,000.
If you are self-employed, your tax bill will be nearly $19,865, roughly $1,637 more in Social Security taxes in 2023 than you paid this year. It's by no means an insignificant amount but not surprising when you consider the large benefits increase next year and given the high levels of inflation.
