Each year, the federal government sets a limit on the amount of earnings subject to Social Security tax. In 2021, the Social Security tax limit is $142,800, up from $137,700 in 2020. This is the largest increase in a decade and could mean a higher tax bill for some high earners. The maximum amount of Social Security tax an employee will pay in 2021 is $8,853.60.
Social Security recipients will also receive a slightly higher benefit payment in 2021. The cost-of-living adjustment (COLA) was increased in October 2020 by 1.3% for 2021, compared with a 1.6% increase for 2020.
- Social Security tax is paid as a percentage of net earnings and has an annual limit.
- In 2021, the Social Security tax limit increased significantly, to $142,800. This could result in a higher tax bill for some taxpayers.
- The cost-of-living adjustment and the retirement earnings exempt amounts are other important changes than can affect an individual’s Social Security benefits.
How the Social Security Tax Works
The Social Security tax, also known as the “Old-Age, Survivors, and Disability Insurance (OASDI) tax,” funds the Social Security program in the United States. As of January 2021, more than 64 million people were receiving Social Security payments of around $1,400 per month. The tax has two parts. The first is the payroll tax mandated by the Federal Insurance Contributions Act (FICA) and the self-employment tax mandated by the Self-Employment Contributions Act (SECA). Medicare tax, or “hospital insurance tax,” makes up the other part.
Payroll taxes are based on an employee’s net wages, salaries, and tips. These taxes are typically withheld by an employer and forwarded to the government on the employee’s behalf. In 2021, the Social Security tax rate is 6.2% for the employer and 6.2% for the employee. Medicare taxes are also split between the employer and the employee, with a total tax rate of 2.9%.
If you are self-employed, you pay Social Security taxes as part of the quarterly estimated taxes you submit to the Internal Revenue Service (IRS). In this case, as you are considered both the employee and the employer, you are responsible for paying the full 12.4%. However, the IRS allows self-employed individuals to deduct the employer portion of self-employment taxes from their taxable income.
While you work, the Social Security taxes you pay are used to fund benefits for existing beneficiaries. Ideally, once you become eligible, current workers will pay into the program so that you can collect benefits. The longer you wait to retire, the more benefits you should receive. However, the Social Security program is facing long-term financing shortfalls that could affect future benefits. Increasing the annual Social Security wage cap is one way to limit the shortfall, but it would not completely solve the problem.
Social Security Tax Limits
The government bases the annual Social Security tax limits on changes in the National Wage Index (NAWI), which tends to increase every year. The changes are intended to keep Social Security benefits on track with current inflation.
Any income you earn beyond the wage cap amount is not subject to a 6.2% Social Security payroll tax. For example, an employee who earns $165,000 in 2021 will pay $8,853.60 in Social Security taxes ($142,800 x 6.2%).
Keep in mind, however, that there is no wage base limit for Medicare tax. While the employee is only subject to Social Security tax on the first $142,800, they will have to pay 1.45% Medicare tax on the entire $165,000. Workers who earn more than $200,000 in 2021 are also subject to an 0.9% additional Medicare tax.
For some high earners, an increase in the Social Security tax limit could result in lower take-home pay. For example, workers who earned more than $137,700 in 2020 and did not get a raise will end up paying more in Social Security taxes in 2021.
|Social Security Tax Limit Example|
|2020 Income||2020 Wage Cap||2020 Social Security Taxes||2021 Income||2021 Wage Cap||2021 Social Security Taxes|
Source: Social Security Administration.
History of Social Security Tax Limits
The Social Security tax rate rarely changes—employees have been paying 6.2% since 1990. However, unlike the tax rate, the Social Security tax limit is adjusted annually.
The federal government increased the Social Security tax limit in nine of the past 10 years. The largest increases were in 2020 and 2021, when the limit increased by 3.6% and 3.7%, respectively.
Cost-of-Living Adjustment (COLA)
The COLA is an annual adjustment made to the Social Security benefit amount. It is measured by the Department of Labor’s Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W). Congress implemented annual COLA adjustments starting in 1975, when inflation rates were extremely high.
The COLA increased by 1.3% in 2021. This means that around 70 million recipients will see an increase in their monthly Social Security payment. However, the 1.3% increase is relatively small. In 2021, individuals will receive $20 more in monthly benefits than they did in 2020 ($1,543, up from $1,523), and married couples will receive just $33 more ($2,596, up from $2,563).
Retirement Earnings Test Exempt Amounts
Workers who receive benefits before they reach full retirement age (FRA) are subject to the retirement earnings test. If your income exceeds certain thresholds, then Social Security will withhold benefits until you reach FRA. Like the Social Security tax limit, these thresholds typically increase annually with the national wage index.
There are two annual earnings test exempt amounts: one that applies to individuals younger than retirement age, and one that applies to individuals who reach FRA during that year. For younger recipients, Social Security withholds $1 for every $2 in excess of their exempt amount. Individuals who reach retirement age will have $1 withheld for every $3 in excess of their exempt amount.
In 2021, the earnings test exemption amounts increased to:
- $18,960 for individuals younger than the FRA
- $50,520 for those who reach their FRA
In other words, an individual who earns $18,960 ($50,520) or less in 2021 may be eligible to receive full Social Security benefits. This is up from $18,240 ($48,600) in 2020.
The Bottom Line
Social Security is an important benefit that helps millions of retirees, disabled individuals, and surviving spouses. The Social Security Administration adjusts benefits each year to keep up with inflation, which often means a bigger payment for recipients. However, the annual increases may not be sufficient to sustain the program in future years. It isn't wise to rely on Social Security to be your only source of income in retirement if you can save more. Many tax-advantaged savings accounts are available to build an additional nest egg.
Social Security Administration. "Contribution and Benefit Base." Accessed March 23, 2021.
Social Security Administration. "Social Security Benefits Increase in 2021." Accessed March 23, 2021.
Social Security Administration. "Cost-of-Living Adjustments." Accessed March 23, 2021.
Social Security Administration. “Research, Statistics and Policy Analysis," Table 2. Accessed March 23, 2021.
Social Security Administration. "What Are FICA and SECA taxes?" Accessed March 23, 2021.
Internal Revenue Service. “Topic No. 751 Social Security and Medicare Withholding Rates.” Accessed March 23, 2021.
Internal Revenue Service. "Self-Employment Tax (Social Security and Medicare Taxes)." Accessed March 23, 2021.
Social Security Administration. “Retirement Benefits." Accessed March 23, 2021.
Social Security Administration. "The Future Financial Status of the Social Security Program." Accessed March 23, 2021.
Social Security Administration. "National Average Wage Index." Accessed March 23, 2021.
Social Security Administration. "Social Security Tax Rates." Accessed March 23, 2021.
Social Security Administration. "Social Security Fact Sheet." Accessed March 23, 2021.
Social Security Administration. "Exempt Amounts Under the Earnings Test." Accessed March 23, 2021.