The Social Security Administration recently updated the maximum taxable wage base that will be used to assess employment taxes and cap monthly retirement benefits in 2015. The new rate is $118,500, which represents a 1.28% increase over this year.
Throughout the last four-plus decades, the SSA has consistently increased the earnings cap on Social Security taxes to reflect the impact of inflation on wages and the average American's cost of living. In 1972, the maximum wage base was a mere $9,000. For the current year -- 2014, that is -- it's $117,000.
The upcoming year's adjustment is the fifth-smallest increase since the early 1970s. It pales in comparison to the double-digit increases in the 1970s and 1980s, which were fueled by rapid inflation.
For the average American, the significance of the maximum taxable wage base is twofold. First, it limits the amount of taxes that employees and employers must pay to fund the country's retirement and disability safety nets. On income below the limit, a 6.2% employment tax is assessed against a person's wages to help fund our pay-as-we-go Social Security system. An identical rate is assessed against the employer.
Let's say, for instance, that you end up earning $100,000 in wages this year. Your share of the tax would be $6,200, and your employer's share would be the same, adding up to a total of $12,400, or 12.4%. If you're self-employed, the entire burden falls on you.
The good news is that any earnings above the prescribed maximum, while potentially subject to a higher income tax rate, are free of the employment-tax burden. If you earned $200,000 this year, for example, only $117,000 is subject to your share of the 12.4% tax.
The flip side of this -- and the second reason the maximum taxable wage base matters to the average American -- is that it also caps the amount of earnings used to determine your primary insurance amount, or the value of monthly retirement benefits you'll receive if you apply for them at your full retirement age.
To calculate this figure, the Social Security Administration takes an inflation-adjusted average of your 35 highest-earning years. It then runs that number through a three-tiered formula that gives you progressively less credit for earnings above certain thresholds -- click here to learn more about how benefits are determined. But due to the cap, you don't get credit in any single year for more than the associated maximum taxable wage base.
|Tiers of Average Indexed Monthly Earnings||Percent Used to Calculate Primary Insurance Amount|
|Less than $816||90%|
|Greater than $816 but less than $4,917||32%|
|Greater than $4,917||15%|
So, in short, the maximum taxable wage base serves as a ceiling on benefits. For example, someone who consistently earned the maximum taxable wage since age 22 and is claiming Social Security benefits at full retirement age this year would earn the maximum monthly benefit of $2,642.
For many Americans, this admittedly makes little difference, as only a small share of the population earns enough in annual wages to be affected by these limits. Nevertheless, for those who do, it's important to keep them in mind both when preparing taxes and planning for retirement.