Social Security Taxes are Boring
Do you know how much Social Security taxes you’ve paid in 2016? Do you even pay attention to this number? Naturally, I wouldn’t have had if it wasn’t through my husband. In general, Social Security taxes are boring. As long you’re earning wages or self-employment income, you’ve no way to minimize these taxes. The money you’re putting into tax-deferred accounts (such as 401(k), 403(b) or HSA) are still subject Social Security taxes. My attitude used to be, “why bother?”.
Then, in 2012, my husband and I started earning wages in California. And my husband’s wage was high enough that this line on one of his paychecks caught his attention.
The Social Security Wage Cap
Have you heard about the Social Security wage cap? Are you aware that each year the Social Security Administration decides on the maximum amount of your wages (including self-employment income) that is subject to Social Security taxes? If you’re a high-income earner, this number can mean significant savings. For 2016, the maximum amount of taxable earnings (the cap) is $118,500.
If your annual income is at $118,500 or below, the full amount of these earnings is subject to Social Security taxes. Right now, 12.4% of every working person’s paycheck goes to Social Security. That includes 6.2% taken directly out of your paycheck, and another 6.2% that is covered by your employer. Self-employed individuals pay the full 12.4%.
If your income is higher than $118,500 (e.g., $168,500), you would only be taxed on the 2016 maximum of $118,500. In other words, $50,000 [$168,500 – $118,500) of your wage is shielded from Social Security taxes. That’s $3,000 in savings [$50,000 x 6.2%]!
Working the Law for Additional Savings
If you are a high-income earner and have stock options to exercise, the maximum taxable earnings number can help you save even more (as my husband and I have learned). How?
Earnings from stock options are treated as ordinary income. This means you need to pay the usual taxes (including Social Security) on those earnings. However, once your total wages reach the maximum taxable amount for Social Security, you no longer pay the Social Security portion on the stock option earnings.
Let’s go back to the hypothetical individual above whose wage was $168,500. This individual was already saving $3,000 on Social Security taxes due to his/her high income. If this person exercises some stock options and gains $10,000, this $10,000 does not get taxed by Social Security. Why? Because his/her income has already reached the 2016 Social Security cap, which is $118,500.
Being aware of this law, my husband has certainly been taking advantage of this savings strategy when we do financial planning. He recently exercised some stock options. All those earnings were not taxed by Social Security. I say a 6.2% savings in taxes is pretty darn good!
Few More Remarks
First, wages that exceed the taxable maximum are not used to calculate Social Security payouts in retirement.
Second, a few months ago, the Social Security Administration announced that the maximum taxable cap in 2017 will be $127,200. This is an increase of 7.34% from 2016! If you’ll be making at least $127,200 in 2017, you would pay an additional $539 over the course of the year.
Third, when you have more than one job in a year, you may end up with total Social Security taxes withheld that exceed the maximum taxable cap. In such cases, you can claim a refund of overpaid Social Security taxes when you file your income tax return.
*In California, the SDI (State Disability Insurance) taxable wage limit is $106,742.