Social Security is America's national pension system. The income limit for maximum social security tax goes up every year. This is because Social Security is underfunded by roughly 25% as of 2022. The 2023 income limit for maximum Social Security tax rose 9% to $160,200.
For those of you who believe the government is efficient and benevolent, this is good news. Looking back, the income limit for maximum Social Security tax was $147,000 for 2022, up from $142,800 in 2021, and $137,700 in 2020. Curiously, for 2022 that equated to only a 2.94% increase versus the 5.9% COLA increase for 2022.
Raising the income limit for Social Security tax brings in more funds. And thereby increases the viability of our national pension system.
Let's look at the income limit for maximum Social Security tax another way in case you're confused. It's also known as the Social Security wage base. What does that mean? After you make over $160,200 in 2023, every additional dollar no longer faces the 6.2% Social Security tax rate.
But, it still faces the Medicare tax for an unlimited amount of income. Therefore, higher income earners do catch a FICA tax break where they see their after-tax income go up. Keep in mind, however, that there is an additional Medicare tax of 0.9% for high-income taxpayers with earned income of more than $200,000 ($250,000 for married couples filing jointly).
Social Security Is Underfunded
It is estimated that Social Security's long-term unfunded liability is now underfunded by $56 trillion. And by the year 2034, Social Security is expected to run out of all excess reserves unless significant action is taken. That would mean that citizens eligible for Social Security in 2034 will only be able to collect ~77% of what is promised on their statements.
Further, due to huge stimulus spending in 2020 and 2021 to combat the coronavirus pandemic, the federal government budget deficit is in an even deeper hole. All hopes are for an economic recovery to bring back much needed tax revenue. However, Biden has also promised to keep the stimulus packages coming to ensure we return to prosperity.
Raising the income limit in 2023 by $13,200 or 9% helps the solvency of Social Security, but it is clear we're all at risk when it's time for us to collect.
The best way to view Social Security is to never expect it to ever payout. The traditional three-legged stool for retirement is obsolete. My new three-legged stool for retirement dictates you must only depend on you (pre-tax savings), you (taxable investments), and you (extra work).
Explaining Social Security Tax
The Social Security tax is a federal tax imposed on employers, employees and self-employed individuals. It is used to pay the cost of benefits for elderly recipients, survivors of recipients, and disabled individuals (OASDI Insurance). OASDI stands for old age, survivors, and disability insurance tax.
Social Security tax is a payroll tax that is automatically withheld on your wage and tax statement each pay cycle. Below is a typical Wage and Tax Statement that shows Social Security tax withheld in box 4 and Medicare tax withheld in box 6.
The Social Security tax rate is 12.4% – 6.2% withheld from the employer and 6.2% withheld from the employee.
The Medicare tax rate is 2.9% – 1.45% withheld from the employer and 1.45% withheld from the employee.
The total Social Security + Medicare (FICA) tax rate is 15.3%. If you are self-employed, you must pay the full 15.3%, but you can take a deduction for half this amount.
The Maximum Social Security Tax Amount And Benefits
Given the new income limit for Social Security tax is $160,200 for 2023 and the Social Security tax born by the employee is 6.2%, the maximum Social Security tax payable by an employee is $160,200 X 6.2% = $9,932.
The maximum Social Security benefit for someone retiring at full retirement age in 2023 is $3,627. This is up from $3,100 in 2022, $2,861 in 2020 and $2,950 in 2021.
However, the average Social Security benefit is closer to $1,827 a month. Receiving the average $21,924 a year in Social Security benefits is nice supplemental income. However, it's simply too low to live comfortably in most places in the US.
Just imagine how stressful it would be if you became ill and needed a bunch of medical treatments or long-term care. That $21,924 could easily be wiped out from medical bills alone.
Click over to my Social Security strategies page to get more ideas. Now, take a look at the historical maximum wages subject to Social Security since 2000 below. Pay close attention to the increases in the wage base. The 9% in 2023 really stands out. It's time to save, save, save!
Self-Employment Tax Is Painful And Unfair
The fact that a self-employed person or small business owner has to pay the full 12.4% Social Security tax and the full 2.9% Medicare tax is a raw deal.
The self-employed person and small business owner are not getting double the Social Security or Medicare benefits. The extra 7.65% tax (6.2% + 1.45%) on operating profits is essentially a business expense. It is an extra cost of being self-employed or doing business, and is, therefore, deductible.
As an employee, you might feel happy about not having to pay the extra 7.65% tax. However, know that there's no free lunch. If your employer didn't have to pay Social Security and Medicare tax, you might have better benefits or a higher salary.
Related: The Best Age To Take Social Security
How To Pay Less Social Security Tax
As an employee, there really is no workaround to paying less Social Security tax. You may feel better about paying Social Security tax when your income surpasses the Social Security tax income limit for the year.
For example, let's say you make $260,200 in taxable income for 2022 as an employee. $100,000 of your income will not be subject to Social Security tax. As a result, the after-tax income you receive on the $100,000 above $160,200 will increase by $9,932.
As an employer, the only way to reduce Social Security tax is to pay your employees less. Same thing as a self-employed person.
If you own an S-Corp, a common strategy was to pay yourself as low a wage as possible to pay less self-employment tax. Then pay as much of your profits in distributions as possible to avoid paying self-employment tax. But I think this strategy is going away with new tax reform.
If you want to reduce your chance of an audit, it's probably best to pay yourself at least the maximum income limit for Social Security tax so the government knows it's getting theirs. You can then figure out a way to reduce your taxable income with strategic business expenses, if you have the revenue and expenses to do so.
The best way to not pay Social Security and Medicare tax is to not earn W-2 or 1099 income. Instead, generate investment income. Investment income isn't subject to Social Security withholding and it is taxed at a lower long-term capital gains tax rate.
If you're unfamiliar with how capital gains works, check out these helpful examples of short-term and long-term capital gains tax calculations.
Build More Retirement Income Through Real Estate
Real estate is my favorite way to achieving financial freedom because it is a tangible asset that is less volatile, provides utility, and generates income. By the time I was 30, I had bought two properties in San Francisco and one property in Lake Tahoe. These properties now generate $200,000 a year in passive income.
Take a look at my two favorite real estate crowdfunding platforms. Both are free to sign up and explore.
Fundrise: A way for accredited and non-accredited investors to diversify into real estate through private eFunds. Fundrise has been around since 2012 and has consistently generated steady returns, no matter what the stock market is doing. For most people, investing in a diversified eREIT is the way to go.
CrowdStreet: A way for accredited investors to invest in individual real estate opportunities mostly in 18-hour cities. 18-hour cities are secondary cities with lower valuations, higher rental yields, and potentially higher growth due to job growth and demographic trends. If you have a lot more capital, you can build you own diversified real estate portfolio.
I have personally invested $810,000 in real estate crowdfunding to generate more retirement income. I don't plan to rely on Social Security benefits in retirement.
Don't Expect To Receive Social Security Benefits
Treat Social Security as an expense to help support older generations who paved the way for your success. If you end up receiving Social Security benefits, then wonderful. It will truly feel like bonus money.
If you don't end up receiving Social Security benefits, then all the same. You helped your elders and never expected to receive any benefits in the first place.
Looking for a free wealth management tool? Sign up for Personal Capital to track your net worth, analyze your portfolio for excessive fees, and make sure your retirement is on track with their Retirement Planner. There is no rewind button in life. Make sure your finances are in order.
For more nuanced personal finance content, join 55,000+ others and sign up for the free Financial Samurai newsletter. Financial Samurai is one of the largest independently-owned personal finance sites that started in 2009. Everything is written based off firsthand experience. The maximum income for Social Security tax is an FS original post.