How the Wage Base Limit Affects Your Social Security

When you work and earn money, you pay Social Security taxes into the Social Security retirement system. Most people pay taxes on all of the income they earn. Social Security benefits you receive are then calculated based on the wages you earned and paid taxes on over the course of your career.

Some people, however, aren't taxed on every dollar they earn -- and they don't get credit for all of their wages when their benefits are calculated. That's because of the wage base limit.

The wage base limit, which is also called the taxable maximum, changes almost every year. It's important to understand the wage base limit because it determines both the taxes you pay and the maximum Social Security benefits you could receive. This guide will explain what the wage base limit is and how it affects your Social Security.

What is the wage base limit?

The wage base limit is the annual limit on the amount of earned income on which you pay Social Security tax. The wage base limit is set annually and is adjusted based on changes in the average wage index. This adjustment ensures that the wage base limit keeps pace with wage growth.

The wage base limit is also the annual limit on the amount of your wages that count when your Social Security benefits are determined. Your Social Security benefit amount is set based on a formula that takes into account the average you earned in the 35 years when you earned the most money. But if you earned above the wage base limit, not all your wages count in determining this average.

If this limit did not exist, someone who made millions of dollars per year would receive tens of thousands of dollars per month in Social Security benefits.

How much is the wage base limit?

The wage base limit changes every year. For 2019, the wage base limit is $132,900. You can find the current year's wage base limit on the Social Security Administration website. The table below also shows the wage base limit for the past several years.

Table source: Social Security Administration.

How does the wage base limit affect the Social Security taxes you pay?

One of the main reasons the wage base limit is important is because it determines the maximum amount of Social Security taxes you pay. That's because you're taxed only on wages up to the wage base limit.

Currently, there is a 12.4% Social Security tax on a worker's wages. Workers with employers pay half their Social Security tax, and employers pay the other half. This means workers pay 6.2% and employers pay 6.2%.

Because of the wage base limit, there is a maximum amount of Social Security tax a worker could potentially pay each year. Since the wage base limit in 2019 is $132,900, the maximum Social Security tax a worker would pay is $8,239.80. The table below shows the maximum Social Security tax owed each year based on the relevant year's wage base limit.

If your income is higher, your effective Social Security tax rate is lower, because you aren't paying taxes on the full amount of money you earn. Someone who makes $20,000 and pays 6.2% tax on his entire wage actually has a 6.2% tax rate. But someone who makes $300,000 would only pay the maximum $8,239.80 in taxes for 2019 -- so his actual Social Security tax rate would be about 2.7466% of his total income. Because of this, many people argue Social Security taxes are regressive.

How does the wage base limit affect Social Security taxes if you're self-employed?

As mentioned above, employers pay half of the 12.4% Social Security tax for workers. But those who are self-employed don't have a separate employer to cover half their taxes.

Self-employed workers must pay the entire 12.4% Social Security tax themselves. The wage base limit still applies to them, though -- but the maximum Social Security tax they pay each year is higher, since they have to pay the entire amount themselves. The table below shows the maximum Social Security tax a self-employed person would pay based on the wage base limit for the past several years.

Self-employed workers are allowed to deduct half of their Social Security tax. This reduces taxable income by half of the amount of Social Security taxes they pay, which helps to offset the fact that employers aren't picking up any part of the cost of the tax.

Medicare does not have a wage base limit

Social Security taxes are authorized under the Federal Insurance Contributions Act, so they are called FICA taxes. In addition to Social Security tax, Medicare tax is also part of your FICA taxes.

Medicare taxes pay for the insurance available to most senior citizens in the United States after age 65. The current tax rate for Medicare taxes is 2.9%. Employers pay 1.45% of Medicare taxes and employees pay 1.45%. Those who are self-employed must pay the entire 2.9% Medicare tax themselves. With the 1.45% Medicare tax and the 6.2% Social Security tax, the total FICA tax rate most workers pay equals 7.65% of income -- and the total FICA taxes a self-employed worker would pay equals 15.3% of income. Self-Employed workers can also deduct half of Medicare taxes from their income.

Medicare, however, does not have a wage base limit. So a worker with income above the Social Security wage base limit would pay Medicare tax on his full income earned but would pay Social Security tax only on a portion of income. There is also an additional 0.9% Medicare tax charged on high earners. This extra tax applies on all wages over $200,000 for most tax filing statuses: above $125,000 if married filing separately or above $250,000 if married filing jointly.

How does the wage base limit affect your Social Security benefits?

The wage base limit also affects the Social Security benefit you receive as a senior. That's because of the way Social Security benefits are calculated. To calculate your benefit, the Social Security Administration:

• Looks at your entire earnings record over your career and adjusts your wages from each year to account for wage growth. The national average wage index is used to adjust your wages to account for growth.
• Adds up your highest 35 years of wages, after adjusting for wage growth, and divides by 420 (the number of months in 35 years of work) to determine your Average Indexed Monthly Earnings (AIME).
• Provides benefits equal to a certain percentage of AIME. Your benefits equal 90% of AIME up to a certain income level, called a bend point, plus 32% of AIME between a first and second bend point, plus 15% of AIME above the second bend point.

Since you only get credit for wages earned up to the wage base limit, this obviously affects your average wage. If your inflation-adjusted wage in 2019 was $350,000, and the entire $350,000 was factored in when determining your average wages, your average wage would obviously be a lot higher than if you only have $132,900 factored into your average.

The wage base limit determines the maximum Social Security benefit

The wage base limit plays a determining role in the maximum Social Security benefit a recipient could receive. A retiree would receive the maximum Social Security benefit only if he or she earns and pays taxes on income equal to the wage base limit for a full 35 years.

The table below shows the monthly maximum a retiree who claimed benefits in 2019 would receive, depending on the age of retirement.

The age of retirement affects the maximum benefit because workers can claim benefits as early as 62 but will receive decreased benefits if they claim Social Security prior to the age designated by law as their full retirement age. Workers also receive increased benefits if they delay claiming Social Security past full retirement age, up until age 70, when benefits don't go up any more. You can learn more about this in our guide to how full retirement age affects your Social Security income.

Table source: Social Security Administration.

Most people do not max out their Social Security benefits because you would have to earn so much money for so many years to do so. Even if you're earning up to or above the wage base limit at the end of your career, you would need to have done so early on in your professional life to earn the maximum taxable wage for 35 years.

How can you tell if you hit the wage base limit?

If you know your income for the year, you can tell if you have hit the wage base limit or if your income exceeds this limit. Simply compare the income you earned that was subject to FICA tax with the wage base limit for the year. If your income was $30,000 in 2018, you won't hit the wage base limit. If income was $200,000, you're above it. You can find the wage base limits for each year on the Social Security website, where you'll see the limit you need to compare your income too.

FICA taxes are calculated based on gross pay, but you only pay FICA taxes on income earned from working. You pay FICA taxes on wages or salary, as well as on profits from self-employment. You don't pay FICA taxes on employer contributions to qualified retirement plans; reimbursement for some business travel expenses; employee insurance; payments made to partners; or S-corporation distributions. Investment income also isn't subject to FICA taxes. So income from these sources isn't counted when you determine if you hit the wage base limit, nor is it counted in determining your Social Security benefit amount.

You can also sign in to your Social Security account and review your earnings record. Visit SocialSecurity.gov and select Sign Up/Sign In to create an account or sign into your existing account. Once signed in, select the option to "View Earnings Record," which is on the main page.

You will see your earnings for each year you worked. The table has three columns and looks similar to the table below, but with many more years of earnings included (assuming you didn't just work in 2017 and 2018).

You'll note there is a column for Taxable Social Security Earnings as well as for Taxable Medicare Earnings. If your Taxable Medicare Earnings are higher than your Taxable Social Security earnings, your income exceeded the wage base limit for the year. This means you didn't pay Social Security taxes on your full income earned -- and you won't have the full value of your wages factored in when determining average income earned over your lifetime. If your Taxable Medicare Earnings and Taxable Social Security earnings are the same, that means your income was at or below the wage base limit, and you paid Social Security tax on the full amount you earned.

In this sample table shown above, the worker earned below the Social Security wage base limit for 2017 but above the Social Security wage base limit in 2018. You'll see these columns for every single year of recorded earnings going back to the start of your career, so it's easy to figure out how many years you exceeded the wage base limit.

What happens if you hit the wage base limit?

Social Security taxes are withheld from your paychecks if you earn a salary from an employer. This means the taxes you owe are taken out of your paycheck by your employer before you receive your paycheck. Your employer sends the money withheld from your paycheck, along with the employer's portion of Social Security taxes, directly to the IRS.

Once your salary hits the wage base limit, your employer is supposed to stop withholding any more money for Social Security taxes. So if you had a very high salary and you made $132,900 in the first six months of 2019, you would hit the wage base limit in the first half of the year. Your employer would stop withholding Social Security tax from your paycheck for the remainder of the year.

If you are self-employed, you must make quarterly estimated tax payments that include payment of your Social Security tax as well as other federal and state taxes. Check out our guide on how to calculate estimated tax to learn more about how this works and how much you must pay over the course of your working year.

What if you earn income from multiple sources and hit the wage base limit?

If you work for multiple employers, you may hit the wage base limit without each employer knowing it.

Say you earn $90,000 from one employer and $45,000 from another during the first nine months of the year. With your two jobs combined, you've now exceeded the wage base limit for the year -- but each individual employer won't know to stop withholding taxes, because that particular employer hasn't yet paid you income above the limit.

When this happens, you can claim a credit toward any taxes owed for the excess amount. If you don't owe any taxes, you can request a refund of the excess amount of Social Security tax you paid.

Should the rules for the wage base limit be changed?

Social Security faces funding shortfalls, and some experts -- and politicians -- have argued that rules regarding the wage base limit should be changed to help shore up the program.

Congress last adjusted the rules for the wage base limit in 1977. At the time of this last adjustment, policymakers set the wage base limit so FICA tax would be charged on 90% of all wages. Future increases in the wage base limit were set to increase annually based on average growth in wages.

However, higher-income earners have seen their wage growth outpace average wage growth -- which means wages above the wage cap have grown faster than average. The result of this is that only around 82% of aggregate wages are now subject to FICA tax. Social Security's tax base has shrunk, prompting some to argue that raising or eliminating the wage base limit is necessary.

If the wage base limit is raised or changed, policymakers would need to determine if higher earners would have the full amount of taxable wages counted in determining their Social Security retirement benefits. This could result in higher earners receiving substantially larger Social Security benefits than are available under the current rules.

Some lawmakers have proposed subjecting more wages to taxes without providing a corresponding increase in Social Security benefits. This would make the Social Security benefits program more redistributive and progressive but would fundamentally change the nature of Social Security as an earned benefit and potentially weaken support for the program.

Now you understand how the wage base limit affects Social Security

Now you have a clearer understanding of how the wage base limit affects your Social Security. The wage base limit determines the maximum amount of income you pay Social Security tax on, and it determines the maximum annual wage that's factored in when determining the amount of your Social Security benefits.

If you want to receive the maximum possible Social Security benefit, you'd need to have earnings equal to or greater than the wage base limit for at least 35 years of your working life. While this is a milestone most people won't hit, earning income at or above the wage base limit at any point in your career will increase the Social Security benefit you receive and could be a goal you want to strive for.